For the most part, exchange-traded funds (ETFs) blindly track indexes that give the greatest weight to stocks with the highest market values. But a growing segment called “smart beta” or “strategic beta” ETFs tweak the indexes in an attempt to generate higher returns and, in some cases, reduce risk. Unlike traditional ETFs, smart-beta ETFs choose investments based on factors such as a stock’s share price momentum, profitability, revenue, dividends and/or volatility. In some cases, they invest in all the stocks in an index equally. They try to reduce one of the biggest vulnerabilities of basic ETFs—that investments with the biggest market values, such as Apple or Exxon Mobil, take up so much of the portfolio that they could cause an ETF to drop sharply or even crash.
There are 462 smart-beta ETFs, with assets totaling $422 billion, and they are attracting nearly one-third of new assets flowing into ETFs. But many smart-beta ETFs have underperformed traditional ETFs. The Financial Industry Regulatory Authority (Finra) recently warned that in addition to being more expensive than traditional ETFs, smart betas can be very complex…may have a heavy concentration in a particular sector or country…and may stray from their stated strategies. What to do: Look for at least a five-year track record of outperforming traditional indexes, reasonable expenses and a simple, understandable methodology.
Attractive smart-beta ETFs now…
PowerShares S&P 500 High Quality ETF (SPHQ) ranks companies by long-term growth and stability of earnings and dividends. It’s a great fit for investors who want less volatility.
Guggenheim S&P 500 Equal Weight ETF (RSP) puts equal amounts into each stock in the Standard & Poor’s 500 stock index. This creates a portfolio that is relatively light in the largest stocks in the index, compared with standard ETFs.