Q. Are smart-beta ETFs better investments?
A. First, what is a smart-beta ETF? These are exchange-traded index funds that alter the weightings of the constituent stocks in systematic ways that their proponents contend will allow them to outperform the indexes long term.
We all know that indexes such as the S&P 500 are capitalization-weighted, meaning the larger companies (i.e. large market caps) have higher weights in the index. We also know that larger companies tend to have limited growth prospects. So in theory, a fund that holds lower weight of larger companies (e.g. smart-beta ETFs) should outperform the straight index fund.
Or do they?
The long-term performance of some of the smart-beta funds as Guggenheim S&P 500 Equal Weight (RSP) and PowerShares FTSE RAFI U.S. 1000 Portfolio (PRF) has beaten the S&P 500 (SPX) handily over the last five years, so it’s hard to argue against the concept.
However, there have been studies pointed out that the reason such smart-beta ETFs outperform the indexes are mainly due to their exposure to "value" and "small cap" stocks, which over the long term, tend to outperform large cap stocks.
So, smart-beta ETFs are just another way to get non-large cap exposures, their stellar performance is probably more due to the wrong benchmark than stellar performance. As an investor, the golden rule still holds - diversify with low cost index funds.
A. First, what is a smart-beta ETF? These are exchange-traded index funds that alter the weightings of the constituent stocks in systematic ways that their proponents contend will allow them to outperform the indexes long term.
We all know that indexes such as the S&P 500 are capitalization-weighted, meaning the larger companies (i.e. large market caps) have higher weights in the index. We also know that larger companies tend to have limited growth prospects. So in theory, a fund that holds lower weight of larger companies (e.g. smart-beta ETFs) should outperform the straight index fund.
Or do they?
The long-term performance of some of the smart-beta funds as Guggenheim S&P 500 Equal Weight (RSP) and PowerShares FTSE RAFI U.S. 1000 Portfolio (PRF) has beaten the S&P 500 (SPX) handily over the last five years, so it’s hard to argue against the concept.
However, there have been studies pointed out that the reason such smart-beta ETFs outperform the indexes are mainly due to their exposure to "value" and "small cap" stocks, which over the long term, tend to outperform large cap stocks.
So, smart-beta ETFs are just another way to get non-large cap exposures, their stellar performance is probably more due to the wrong benchmark than stellar performance. As an investor, the golden rule still holds - diversify with low cost index funds.
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