The market value of a company often doesn’t jibe with its intrinsic value, causing its share price to be either overvalued or undervalued at any given time. The latter creates opportunities for investors, and the Diamond Hill Valuation-Weighted 500 ETF (DHVW) that launched this week aims to benefit from that with a strategy based on the concept of intrinsic value.

The fund tracks an index created by Diamond Hill Capital Management, a unit of  Columbus, Ohio-based Diamond Hill Investment Group Inc. that has roughly $16.4 billion in assets under management among its mutual funds, separate accounts, private investment funds and its first exchange-traded fund.

The Diamond Hill Valuation-Weighted 500 index that underpins the new ETF consists of the 500 largest U.S.-listed equities weighted by intrinsic value capitalization.

According to fund literature, the index starts with the 700 largest U.S.-listed companies based on market capitalization and then trims that down to the 500 companies with the largest intrinsic value capitalization based on Diamond Hill’s proprietary valuation methodology that estimates the projected earnings power and future cash flows of each company. The formula is based on normalized earnings and earnings growth, along with expected dividends to be paid over the next five years and projected tangible book value.

Each constituent is then weighted based on its calculated intrinsic value relative to the total calculated intrinsic value of companies in the index. The index is reconstituted and rebalanced quarterly, and at times might not comprise exactly 500 companies due to acquisitions, spin-offs or other corporate actions.

“Most people would call this a value-oriented fund because all of the work done to estimate intrinsic value is forward looking, but it's still discounted back to the present,” says Ric Dillon, CEO and portfolio manager at Diamond Hill. “Not surprisingly, the strategy tends to overweight companies that are undervalued and underweight companies that are overvalued.”

The Diamond Hill Valuation-Weighted 500 ETF is part of the growing roster of strategic-beta, or smart-beta funds that employ various non-market-cap-weighted strategies. Proponents of strategic beta say market-cap weighting tends to overweight overvalued stocks and underweight undervalued equities.  

Dillon believes his firm’s approach is unique in the industry. “To the best of our knowledge, our fund is the only one using forward-looking information to estimate intrinsic value,” he says.

The fund’s top 10 holdings are Apple, Microsoft, Google, Wells Fargo, JPMorgan Chase, General Electric, Gilead Sciences, Facebook, Johnson & Johnson and Wal-Mart Stores.

The management fee of 0.45 percent is capped at 0.10 percent until at least next April.

The new ETF originally existed as a limited partnership created at the end of 2011. That private fund used the same index methodology as its successor ETF, and generated annualized returns over three years (through year-end 2014) of 20.87 percent versus 20.41 percent for the S&P 500 index.

Dillon says they decided to convert the private fund into its new iteration because its passive bent works well as an ETF. That, and it gives Diamond Hill experience with ETFs and sets the stage for potentially expanding into the space with offerings based on its active-fund strategies if and when regulators open the door for non-transparent, active-strategy ETFs.

This strategy [the new ETF] lets us learn a lot about the ETF world,” Dillon says.