May 30, 2016
Personal Investor: Smart beta ETFs, dumbed down
By Dale Jackson
ANALYSIS: Smart beta is the latest evolution in exchange traded funds, but even some experts say smart beta has become the victim of dumb marketing.
Deborah Fuhr, partner at research firm ETFGI LLP considers 809 of the 5,000 ETFs in her database to be smart beta, but admits even index providers can’t agree on what smart beta really is.
Canadian ETF pioneer Som Seif hates the term “smart beta” and prefers to call it “factor investing”.
No matter what you call it there is an estimated US$375 billion in so called smart beta ETFs worldwide – a 30 per cent increase over the past five years. There are around 1,000 funds that could be considered smart beta – a few trade in Canada but most trade on U.S. exchanges.
To understand smart beta and how it might fit into your portfolio, it is best to first understand how the standard market-weighted ETF works.
The good old ETF
Traditional ETFs track market weighted indices, like the S&P 500, directly by attempting to purchase the same companies according to their current market value.
As those values – or weightings – change, the ETF will purchase more or less accordingly. If the index rises ten percent, for example, the ETF should rise proportionally minus an annual fee that is usually about ten basis points (one-tenth of a per cent).
Smart beta graduates from the index
Smart beta ETFs go beyond the index by using other factors such as equal weighting where every company in an index has the same value.
Other smart beta strategies seek to minimize volatility or focus on criteria more closely tied to the economic fundamentals behind a country or sector.
And then there are the ETFs that fall somewhere in between. Other smart beta methodologies include fundamental factors for selecting companies in an ETF such as sales, cash flow, book value or dividends – which have been gaining in popularity.
Passive versus active
The biggest difference between conventional ETFs and smart beta is how they are managed. Conventional ETFs are passively managed, meaning the underlying index determines the holdings instead of a manager.
Smart beta funds require management decisions, much like a mutual fund – but less expensive. A smart beta ETF will typically impose a 50-to-60 basis point fee each year compared with a typical 250 basis point (2.5 per cent) fee for a mutual fund.
Smart beta ETFs are relatively new to the market, making it hard to gauge their long term performances.
They can get complicated, so smart investors will speak with an advisor before investing in smart beta.
Dale Jackson is BNN's Personal Investor. Follow him on Twitter @DaleJacksonPI
