One of the big complaints about index-based investing is that when you buy an index, you're indiscriminately buying a basket of stocks, regardless of the relative quality of each egg that populates it. A few rotten ones can taint an otherwise well-prepared omelette.
That's why the chefs in the kitchens of Standard & Poor's have whipped up a new concoction that aims to weed out the weakest stocks in Canada's S&P/TSX 60 blue-chip index and largely toss them out of the mix - while adding an extra dash of the most tasty ingredients in the index.
It's called the S&P/TSX 60 130/30 Strategy Index, unveiled yesterday.
S&P/TSX 60 - WITH A TWIST
The new index - upon which a new exchange-traded fund from Horizon AlphaPro will be based - takes the existing S&P/TSX composite index (in which stocks are weighted based on market capitalization) and assesses the stocks based on a set of fundamental and quantitative criteria, to identify which ones are more likely to be outperformers and which are more likely to be underperformers.
The criteria include analysts' average recommendations, earnings yield, dividend yield and S&P Quality Ranking, which is an indicator of earnings and dividend stability.
S&P takes the top-10 highest-ranked stocks under these criteria and boosts their weightings in the index by 3 percentage points, and takes the bottom-10 stocks and reduces their weightings by 3 percentage points. (Since most of the stocks on the S&P/TSX 60 have an index weighting of less than 3 per cent to start with, this means that the 130/30 index will take on short positions in most stocks in the underweight basket in order to lower their weightings by the full 3 percentage points.)
Effectively, this means the index is taking the 10 strongest investment ideas in Canadian blue-chips - based on relatively objective criteria - and loading up on them, while taking the 10 weakest links and either scaling back on them or actually shorting them.
DIGGING UP THE VALUE
