This index ETF is beating the S&P 500 by excluding ‘losers’ Deep Dive

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The coronavirus economy is a big problem for Coca-Cola because of the disruption to the physical distribution of its products through restaurants, vending machines and sports facilities, said Will Rhind, CEO of GraniteShares.

Index-fund investors who didn’t sell into a crashing stock market in March should be pleased, as the S&P 500 has returned 1% in 2020. That’s despite a drop of as much as 30% earlier this year.

Active fund managers want to beat the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.39% , but most can’t do it because it’s difficult to pick winners and higher fees depress returns.

Will Rhind, the founder and CEO of GraniteShares, explained a passive approach that aims to beat the broader market, but not by selecting winners. The strategy of the GraniteShares XOUT U.S. Large Cap ETF /zigman2/quotes/214552578/composite XOUT +1.24% is to exclude companies with weaker growth prospects.

“We think the traditional passive approach, regardless of whether it is a good company or a bad company, is fundamentally flawed,” he said in an interview.

XOUT was established Oct. 7. Here’s how it has performed against the S&P 500 Index since then:

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XOUT ranks the 500 largest U.S. companies by a fundamental scoring methodology and excludes the 250 with the weakest scores. The ETF is rebalanced each quarter and is weighted by market capitalization. Its annual expense ratio is 0.60% of assets, which seems high when compared with a ratio of only 0.09% for the SPDR S&P 500 ETF /zigman2/quotes/209901640/composite SPY +1.38% . Then again, expenses are included in the ETF’s return, shown above, and it has performed very well against the S&P 500 Index (which, of course, has no expense ratio).

Nine months isn’t a long period to compare a fund’s performance to a benchmark. However, this period has been a roller-coaster ride, and the XOUT approach may appeal to investors who want a more focused approach to the stock market, without narrowing down to particular sectors, however hot they may be.

Rhind founded GraniteShares in 2017 after previously working at Barclays Global Investors (which started iShares and was acquired by BlackRock in 2009) and ETF Securities (acquired by Wisdom Tree in 2018).

He explained that XOUT’s analysis of the 500 largest U.S. companies encompasses seven categories, in no particular order: