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The AlphaDEX® Methodology: The Quintessential Smart Beta Product

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Market Realist: So let’s move on to the AlphaDEX suite of products. Walk us through its construction, its goals, and benefit to investors.

Dave: Sure. The AlphaDEX methodology is, at its core, the quintessential smart beta product. It is the methodology that most encapsulates all the research from Fama-French with respect to size, value, risk, and growth or momentum and bundles them into a singular process, selecting the best of that. It utilizes a weighting methodology that’s designed to overweight the stocks that have the highest ranking and underweight the stocks that have the lowest ranking from this scoring process while removing those that are not in the top part of that ranking. And so, we use a multi-factor approach, evaluating each stock based on a series of growth factors and value factors. Each stock is ranked by these factors and then gets assigned a growth or value rating based on those figures. We look at the stocks that are best in each. Depending on the universe in which we’re selecting, a number of securities are selected. It could be the top 20% based on the scoring or the top 25%, depending on the underlying markets’ liquidity and capacity. From there, we rank the stocks based on their quintile scoring, so the top quintile gets 33%, the next quintile gets 26%, the third gets 20%, then 13%, then 6%, and everyone below that is not included in the index. When we think about AlphaDEX, we really see this as taking the best of names that utilize known return drivers, this is the Fama-French story. We then utilize the size aspect of close to equal weighting but not quite equal weighting. We take advantage of that as a return driver and create a quintessential smart beta strategy.

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Market Realist’s View: The NASDAQ AlphaDEX Total US Market Index

The NASDAQ AlphaDEX Total US Market Index employs the AlphaDEX stock selection methodology to select stocks from the NASDAQ US Benchmark Index.

The financial sector (XLF) is the largest constituent of the index with 24% of the portfolio, followed by the industrial sector (18.2%)(XLI), consumer services (14.7%), consumer goods (11.3%), and technology (9%)(VGT).

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