Around 790 companies make the cut and are all included in the index on an equal-weighted basis. The index methodology produces very low weightings in sectors which don’t have much innovation such as real estate, financial services, telecom and energy.
Analysts at Knowledge Leaders Capital backtested a hypothetical index over an 18-year stretch going back to 2000 and found the index rose 409.9 percent (through December 31, 2018), compared to an 86.9 percent return for the MSCI World Index.
That’s a staggering level of outperformance.
The nations with the highest levels of innovation include Denmark, which on average spent the most on R&D as a percent of sales, followed by the U.S., Israel and Switzerland. Danish firms also are world leaders regarding spending on advertising and branding.
Coward says companies included in the index bring a pair of virtues. Not only are they capable of delivering excess market returns but they tend to do so with lower volatility levels, as evidenced by the fund’s beta of 0.79. That could be due to the balance sheets of the firms that are in the underlying index. Coward adds that highly innovative firms tend to use less leverage, and those with smaller debt levels tend to see their stocks trade in a smoother fashion during economic downturns.
The Knowledge Leaders Developed World ETF began trading in July 2015, and its three-year average annual returns of 10.8 percent exceeds the 9.6 percent annualized return of the MSCI All-Country World Index in that time. That compensates for the fund’s 0.75 percent expense ratio.
It’s the above-noted impressive long-term results for the index that likely explain how the fund has attracted more than $125 million in assets, no small feat for a fund backed by a little-known firm that lacks the breadth and distribution of larger fund families.
Not Just Another Factor
Coward is quick to stress the “Knowledge Effect” shouldn’t be lumped in with the much-touted set of five factors that underpin many ETFs these days: size, value, momentum, quality and volatility.
“We looked at how these factors correlated with market returns, and none of them appear to deliver sustainable excess returns as the knowledge effect does,” says Coward.