Some investment strategies are obtuse and wonky. Others are simple and intuitive. The M.O. behind the American Customer Satisfaction Core Alpha ETF (ACSI), which launched on Tuesday, fits the latter category—at least on the surface.

ACSI is the first exchange-traded fund from asset manager ACSI Funds, which specializes in investment products based on the American Customer Satisfaction Index created at the University of Michigan.

“The premise is that a company whose customers are pleased with its goods and services is likely to outperform companies whose customers are less satisfied,” says Kevin Quigg, chief strategist at ACSI Funds, adding that quantifying that qualitative premise is easier said than done. “That’s where the math and science comes in.”

As Quigg explains, it's a twofold process of gathering information through surveys that produce more than 100,000 pieces of input from different customers regarding the goods and services they receive, and then pairing that with a proprietary econometric model developed by Claes Fornell, a professor at the University of Michigan’s Ross School of Business who’s considered an expert on marketing science and on the relationship between customer satisfaction and the performance of securities. The model interprets customer information and compares companies both in the same industry and across different industries.

According to the ACSI fund’s prospectus, a company’s ACSI Score is calculated based on questions that measure customer expectations, perceived quality, perceived value, customer complaints and customer loyalty.

“We like to think it’s an intuitive and straightforward process that’s differentiated from some of the traditional smart-beta products,” says Quigg, who says his company considers the ACSI fund to be an enhanced-beta product. “It’s a different way to gain outperformance from the market versus sort of mining the same quarry—for lack of a better term—where a lot of the smart-beta providers are.”

Specifically, the ETF’s underlying index incorporates customer satisfaction metrics for more than 350 brands representing more than 150 mainly large-cap companies. Sector constraints are applied at each quarterly index rebalancing to ensure a diversified portfolio across all U.S. sectors. Individual stocks are weighted within each sector by their relative customer satisfaction scores, and at rebalancing the max weighting for a holding is 5 percent.

The ACSI fund’s top 10 holdings comprise familiar names including Apple, Johnson & Johnson, Alphabet and Microsoft. But that group also includes small-cap Vonage Holdings, formerly a consumer-focused Voice over Internet Protocol company that ran quirky television ads but whose stock price was pummeled during the latter part of the prior decade. It has since transformed itself into a provider of cloud communications services for consumers and businesses, and evidently it scores high in customer satisfaction rankings.

“The point of the portfolio is to provide broad U.S. exposure, mainly in the large-cap market, but in a diversified way across the sectors,” Quigg explains. “In some sectors, you’ll have smaller companies with greater market share—Vonage is a good example—where relative to their industry competitors they have a promising score. Because of that, it [Vonage] has an overweight and that’s reflected in the top 10 ranking.”

Gimmicky?

The American Customer Satisfaction Core Alpha ETF is the latest in a slew of seemingly niche products on the market that are either hyper-focused on a particular industry or distinctively structured to stand out from the crowd. Naysayers view these products as gimmicky, and a number of these funds have struggled to attract assets.

But Quigg, a 20-year ETF industry veteran who previously headed State Street Global Advisors SPDR ETF’s global sales strategy, global capital markets and institutional ETF sales groups, naturally believes the ACSI fund employs a premise and methodology that can lead to consistent and substantive market returns.

“Customer satisfaction is a precursor on how well a company can do,” he explains. “The buyers [of a company’s products] are consistently under heard in the investment marketplace, and we think we have a means to continually integrate new information into a model that will lead to consistent outperformance.”

Hedge Fund

The American Customer Satisfaction Index came about in 1994 from a collaboration between Fornell and other University of Michigan researchers, the American Society for Quality in Milwaukee, and CFI Group in Ann Arbor, Mich. It was used by some central governments to forecast economic figures and in academic research, among other purposes.

But when Fortune 500 companies approached Fornell to better understand what he was doing, Quigg explains, it got Fornell thinking about translating his index into financial purposes. Fornell founded ACSI Funds, and in 2000 the company created the CSat Classic-Long/Short Hedge Fund, which invests in U.S.-listed large-cap equities as measured by the American Customer Satisfaction Index.

Because this is a traditional long/short hedge fund with no constraints, it’s not a proper comparison tool for investors seeking to divine how the newly launched ETF could perform.

“They’re different vehicles meant for different parts of your portfolio. The engine embedded in both of them is the same, but the purposes of the vehicles are different so that the experiences will be different,” says Quigg, who adds that from a macro standpoint most of the hedge fund’s outperformance comes from its long positions.

The hedge fund is meant for the alternative sleeve in investor portfolios, Quigg says, whereas the ETF, while it uses the same customer satisfaction data used by the hedge fund, is intended to be a core U.S. equities holding.

“We put a rules-based methodology behind the ETF,” he says. “There are no rules in a hedge fund. We made sure the ETF is diversified with a 10 percent band around the S&P U.S. sectors.”

The ACSI ETF has a net expense ratio of 0.68 percent. That seems in line with other smart beta-type index-based strategies, but investors can get less expensive core U.S. equities exposure by investing in a pure market cap-weighted passive ETF.

“We think that is a choice, but we think the growth of smart-beta is a sign that people are growing disillusioned with traditional cap-weighted management,” Quigg says. “We think this is an alternative, and it’s a way to get the same beta exposure but with an opportunity to outperform. Whether you look at traditional cap-weighted funds or our fund, at the end of the day if you’re getting the same level of volatility and risk but one gives you the outperformance that more than covers it expense, we think it’s a good proposition.”

In the end, investors will express their level of customer satisfaction by either investing—or not investing—in this ETF.