Chicago-based Distillate Capital has launched a new ETF targeting US mid and small-cap companies with robust quality and value characteristics.
Thomas Cole, CEO of Distillate Capital.
The Distillate Small/Mid Cash Flow ETF (DSMC US) has been listed on NYSE Arca with an expense ratio of 0.55%.
The actively managed fund uses Distillate’s own factor definitions within its selection process. This involves making a number of balance sheet adjustments to enhance the comparability of factors across firms.
The investment process first excludes stocks with significant leverage based on Distillate’s proprietary debt-to-income ratio that adjusts for off-balance sheet leases or other calls on capital that may not be picked up by traditional measures.
Each company is then scored based on a proprietary measure of the volatility of its historical and projected cash flows as an indicator of fundamental stability. Distillate utilizes a cash-based proprietary measure called ‘distilled cash yield’ which it says restores comparability between older, more physical asset-based companies and newer, more research and development-oriented ones.
Finally, each company is scored based on a proprietary measure of free cash flow yield (a measure comparing a company’s normalized free cash flow to its enterprise value). Distillate’s proprietary metric seeks to address the perceived ineffectiveness of traditional valuation methods which stem from the differing accounting treatment of intangible and physical assets.
Following these adjustments, the ETF aims to include approximately 150 stocks that have scored favourably across Distillate’s proprietary metrics.
Commenting on the new listing, Thomas Cole, CEO of Distillate Capital, said: “To this point, small and mid-cap offerings have not taken a discerning eye to this universe of stocks, ignoring the significant dispersion to be found across valuations, high levels of leverage on the books of many names, and the fact that almost 20% of companies making up the largest small-cap index are not expected to generate positive free cash flow in the next twelve months. Across market caps and exposures, we believe in selectivity, and this category, in particular, requires a systematic methodology when looking at the true fundamental value factors and risks of each stock.”
The fund complements Distillate’s two existing ETFs – the $770m Distillate US Fundamental Stability & Value ETF (DSTL US) and $20m Distillate International Fundamental Stability & Value ETF (DSTX US). These ETFs are 100% passive, tracking proprietary indices that are based on the investment approach described above. DSTL and DSTX are focused on US large-cap and global ex-US equity markets and come with expense ratios of 0.39% and 0.55%, respectively.