Get a Boost with Medical Stocks and First Trust Health Care Alphadex Fund

published 21 July 2011

The health care sector is charging ahead as investors gravitate toward defensive stocks because of concerns about a sputtering recovery. First Trust Health Care AlphaDex Fund, one of the top exchange-traded funds in the sector over the past three years, is no ordinary index fund. That’s because the ETF relies on a proprietary enhanced index that grades stocks by investment merit rather than by a company’s size.

The index ranks all of the health care stocks in the Russell 1000 index. That index contains the 1,000 largest publicly traded U.S. firms, and currently 96 are in the health sector. The ETF’s index then evaluates each company on six factors. Three -- price to book value, price to cash flow and return on assets -- relate to valuation. The others -- share-price momentum, sales growth and price to sales -- are in the index’s growth model.

The index drops one-fourth of the stocks with the worst rankings. The index’s overseer divides the rest into five “buckets.” The 15 or so highest-ranked stocks land in the first bucket, which accounts for one-third of the index; inside the bucket, each stock accounts for about 2.2% of assets. Fifteen more stocks go into a second bucket, accounting for 27% of the index. The process is repeated among three successively smaller buckets. The index is rebalanced quarterly. The result: a fund that holds more midsize firms and fewer large drug makers than are typically found in health care index funds.