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
XOUT,
-0.86%
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:

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
SPY,
-0.47%.
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:

• Revenue

• Employee growth

• Research and development investment

• Stock buybacks

• Profitability

• Earnings forecasts

• Management score

Each company is assigned a numerical ranking, and the lowest 250 are excluded when the fund rebalances each quarter.

Rhind said the scoring and rebalancing “avoid companies that are going to be disrupted, or are in secular decline.”

Five biggest companies excluded

Rhind said XOUT is “not a tech fund,” but also said technological disruption is one of the threats the ETF is trying to avoid when excluding companies. As of July 16, the information technology sector was the ETF’s largest, making up over a third of the portfolio:

The fund’s fact sheet includes updated lists of top holdings and the largest companies excluded from the fund. Rhind commented about the five largest companies excluded:

• Procter & Gamble Co.
PG,
+0.14%
 is the largest company currently excluded from XOUT. “It is not that the data indicate P&G is seriously amiss, merely that the company is falling into a pattern of stagnation and atrophy,” Rhind said. He cited decelerating earnings and sales expectations, based on analysts’ consensus estimates. With a very slow rate of sales growth, Procter & Gamble’s management score within the XOUT model is “18% below market average,” he said. “None of this is to say that PG’s prospects are forfeited, simply that the company is not at the vanguard of embracing digital disruption, and investors may have better options available,” he added.

• J.P. Morgan Chase & Co.
JPM,
+0.11%
 was excluded from XOUT before the coronavirus crisis for several reasons. These included “decelerating deposit growth,” as well as share repurchases that “were funded by borrowed money, effectively, and not from free cash flow,” Rhind said. He also said expected revenue and earnings were declining.

• Rhind called Verizon Communications Inc.
VZ,
-0.53%
“a leader at divesting human capital,” since it has been “firing over three times faster than the market is hiring.” He also cited revenue pressure, with sales “increasing, but at an anemic 0.5%.”

• AT&T Inc.
T,
+1.04%
 ”is a company responding to technological change, as opposed to leading it,” Rhind said. He added that AT&T’s revenue growth was coming from its Time Warner acquisition, and that it scored low for revenue growth and that it was also shrinking its employee base.

• When discussing Coca-Cola Co.
KO,
+0.13%,
Rhind had this suggestion for investors: “Consider the extent that sugar water provides innovation.” He also said the company’s expected earnings growth is “in the bottom 2% for the entire large-cap space.” He pointed to the coronavirus economy as a terrible problem for Coca-Cola, because of the disruption to the physical distribution of its products through restaurants, vending machines and sports facilities.

Top holdings

Rhind said for companies selected for inclusion in the XOUT portfolio, “the closest analogy is the ESG world.” Here are the ETF’s top 10 holdings:

First, though, a walk down memory lane. Wellesley Income
VWINX,
+0.58%
 ] was created in July 1970 by the Wellington Management Co., at which a gentleman by the name of John Bogle was working. Bogle would later create the Vanguard Group of mutual funds, and the Wellesley Income fund became one of its offerings. Wellington Management continued to manage the fund.

The fund falls in the “Balanced” category, averaging about a 35% allocation to stocks over the decades and 65% in bonds. Despite therefore being rather conservative, it has produced a quite respectable 9.7% annualized 50-year return through this past July 31, according to investment researcher Morningstar. 

Over this same period, the entire U.S. stock market, as measured by the Wilshire 5000 Total Return Index, produced an 11.0% annualized return. Long-term Treasurys, intermediate-term Treasurys, and long-term corporate bonds produced annualized returns of 8.8%, 7.0%, and 8.3%, respectively.

Vanguard Wellesley Income is slightly ahead of a strategy that had a constant 35%/65% stock/bond allocation over the past 50 years and invested the bond portion in an index benchmarked to either intermediate-term Treasurys or corporate bonds. As you can see from the accompanying chart, however, the fund would have slightly lagged a hypothetical index fund portfolio that allocated the bond portion to long-term Treasurys.

Since the vast majority of mutual funds don’t even match their benchmarks, much less slightly beat it, Wellesley Income’s return puts it well-above average. In any case, it’s unfair to compare it to a portfolio of index funds, since such funds didn’t even exist in 1970. The Vanguard 500 Index Fund
VFINX,
+1.50%,
  Bogle’s landmark invention, wasn’t created until 1976. According to an article in Barron’s several years ago, furthermore, the first bond index fund wasn’t created until late 1986 (the Vanguard Total Bond Market Index Fund
VBMFX,
+0.27%
 ). Given that, Wellesley Income’s achievement is even more impressive.

Another way of appreciating Wellesley Income’s achievement is to focus on the attrition rate among mutual funds. I am unable to find out how many mutual funds existed 50 years ago, so I can only estimate how few of them exist today. Researchers have found that, between 1962 and 1995, the average annual mutual-fund attrition rate was 3.6%. If we assume that rate for the entire 50 years of Wellesley Income’s life, that means that just 16% of the funds that were in existence in 1970 are still around today.

Another estimate of attrition comes from S&P Dow Jones Indices. In their year-end 2019 SPIVA U.S. Scoreboard, they report that just 44.53% of all domestic funds that existed at the beginning of 2005 were still in existence at the end of 2019 — equivalent to an attrition rate of 5.25% annualized. Assuming that was the actual rate each year since 1970, only 7% of that year’s funds would still be in existence today. Regardless of which attrition rate you assume, it is clear that Wellesley Income is among a small minority.

Mixing stocks and bonds

All of this begs the question about how this 50-year old fund will perform in the future, however. Index funds are widely available now, and if the fund is so closely correlated with the long-term returns of a blended stock-bond benchmark index, you could very well ask if it’s worth the effort. Your answer will rest in part on whether you’re willing to bear the risk of lagging that benchmark in order to preserve the possibility of outperforming it.

What I want to focus on, however, is whether the 35%/65% stock/bond split pursued by Wellesley Income is out-of-date. Many argue that it is, including such investment legends as Burton Malkiel, the Princeton University economist and author of the famous book, “A Random Walk Down Wall Street.” Recently Malkiel told MarketWatch reporter Andrea Riquier that there no longer is justification for even a 60%/40% stock-bond portfolio, much less a 35%/65% split.

I’m not so sure, however. Consider a recent analysis completed by Joe Tomlinson, a financial planner, actuary and retirement researcher. He focused in particular on the impact during retirement years of moving from a 60% stock/40% bond portfolio to one that is 75%/25%. He found that, on average across thousands of simulations, this move led to a surprisingly small increase in the amount the median retiree could withdraw each year. But what that move did do was greatly expand the range of possible outcomes — from very good at one end of the extreme to very bad at the other.

One of the major implications of Tomlinson’s analysis is that increasing equity exposure may not be worth the risk. If you do, he adds, you should have a separate “solid base of secure lifetime income” with which to pay for basic needs. “Relying on stock-heavy portfolios to meet basic needs carries a lot of risk.” If you’re persuaded by this analysis, Wellesley Income may be an attractive consideration.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More:Should I still use the 60/40 investing rule for retirement?

Also read: Vanguard opposes a tax on Wall Street its founder John Bogle favored — and the reason may surprise you

The promise of clean tech — creating energy from renewable resources — has lured investors to the space before, only to get burned. After years of underperformance is now different or are buyers once again flying too close to the sun?

Energy-market watchers say what makes today different than 10 years ago, when interest in clean tech also was hot, is that these power sources are now economically viable as subsidies fall away.

Peter McNally, global lead for industrials, materials and energy at research firm Third Bridge, says aggressive investment by utilities in renewable energy has lowered the cost of clean tech and showed it was viable at scale. Just as utilities invested in natural gas 20 years ago at the expense of coal, they are now doing the same with alternative energy.

“Clean-tech businesses are starting to stand on their own, and I think they got a big boost from the utilities,” he says.

Data from the U.S. Energy Information Administration, the statistical arm of the U.S. Department of Energy, shows as of 2019, 18% of the U.S.’s electricity generation came from alternative energy, versus 10% in 2009.

Some of the big oil majors like BP
BP,
+0.56%
BP,
+0.56%
 are taking alternative energy seriously, McNally says, pointing to BP’s announcement that it will allow oil production to decrease by 40% over the next decade while investing $5 billion by 2030 in clean tech.

“I am less cynical about the whole thing than I had been in the past (because of) big oil,” McNally says.

Another difference between now and then is clean tech is rallying as crude-oil flounders, says Jason Bloom, director of global macro ETF strategy at money manager Invesco.

Until a few years ago, alternative-energy prices were significantly higher than fossil-fuel prices. Users would seek alternatives when fossil-fuel prices rallied, switching back when prices fell. While the cheapest fossil-fuel generation still beats out clean-tech energy, in some areas of abundant sun and wind, unsubsidized new-generation wind and solar prices are competitive at utility scale as clean-tech prices plummeted over the years, Bloom says.

Over the past 10 years, the cost of solar panels has plunged 82%, while onshore wind costs have skidded 39% and the cost of offshore wind has fallen 29%, according to the International Renewable Energy Agency.

Solar names are leading this year’s rally, says Angelo Zino, senior industry analyst at CFRA, a research firm. He attributes some of it to investor interest in Tesla’s
TSLA,
-2.30%
electric vehicles and the ripple effect on other industries, plus increasing interest in environmental, social and governance investing. There may also be some investor bets that Joe Biden will win the White House in November and increase initiatives around clean energy, specifically solar.

The First Trust NASDAQ Clean Edge Green Energy Index Fund has Tesla as its second-biggest holding, while the Invesco Solar ETF and iShares Global Clean Energy ETF have SunRun
RUN,
-5.31%
 as their No. 3 and No. 1 holding, respectively, according to their websites.

Biden’s platform has ambitious targets to increase renewable energy production, including establishing national goals of 100% clean energy by 2035. “You’ve got the potential with him at the helm to really accelerate a ton of the initiatives and long-term objectives of clean energy,” Zino says.

Because clean tech is a young space, investors need to brace for volatility. If a Biden presidency doesn’t occur, Zino expects the valuation of these stocks to fall back because Donald Trump won’t make renewable energy a priority.

Read:The West burns, coastlines are threatened, and Trump and Biden are too quiet on climate change, say analysts

For now, there are some limits to how much of power generation can come from renewables even at utility scale. Battery technology needs to improve so utilities can tap more stored electricity when the sun isn’t shining or the wind isn’t blowing. “They’re figuring ways to make it more reliable, but it’s not 100%,” Third Bridge’s McNally says.

But even if the U.S. slows in renewables adoption, clean tech is a global business. Europe and China are pushing ahead on adoption, which supports the industry as a whole. For example, Germany gets nearly half of its energy from renewables, according to Clean Energy Wire, citing Germany’s energy industry association.

McNally says the strength in clean-tech energy is more than just investor money inflating valuations, pointing utility NextEra Energy
NEE,
-1.49%,
the world’s largest generator of renewable energy from wind and solar power.

“The utilities themselves have made this part of their portfolio, and they are required to keep the lights on,” he says. “They’re investing real money in all kinds of ways to generate and distribute power to customers.”

Now read:Warren Buffett-backed largest U.S. solar project approved as nation’s renewable use on track to pass coal

Also:Here are two stocks that stand to benefit from California’s electric-vehicle push

Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.