Smart Beta Funds: "A Very Smart Choice"

09/03/2015 9:00 am EST

Focus: STOCKS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

The world of ETF investing is becoming increasingly trendy and I don’t mean that in the fleeting fashion sense. Rather, I mean that in the sense of the market response from the variety of great ETF providers, explains Doug Fabian, editor of Successful ETF Investing.

As more investors embrace ETFs, more ETF offerings are coming to the market and the variety of different funds designed with different objectives in mind has been great for the industry, and more importantly, for investors.

One of the biggest trends in ETF land these days is the rise of so-called smart-beta ETFs. These ETFs provide a twist on traditional indexed ETFs and they’re an interesting alternative to traditional, market-cap-weighted index funds.

I sort of think of smart-beta funds as hybrid strains of passive investments you get with index funds and actively managed mutual funds with a team of analysts at the helm buying and selling stocks or bonds.

With smart-beta ETFs, you get the benefits of an active market bet, with the more objective guidelines for buying and selling stocks or bonds that are traditionally associated with passive index investing.

Another great part about smart-beta ETFs is low fees. In fact, expense ratios are far lower than those of actively managed mutual funds, in many cases even lower than some traditional index mutual funds.

One of the most common types of smart-beta funds is those that offer equal weighting, meaning each stock counts the same in an index.

Funds such as the Guggenheim S&P 500 Equal Weight ETF (RSP) invest in the same companies as the traditional market-cap-weighted S&P 500 index.

But unlike the market-cap-weighted index, RSP doesn’t weight the likes of Apple (AAPL) or Microsoft (MSFT) more than smaller index components.

By equal weighting, the smaller-cap, lesser-known S&P 500 companies get treated the same as Apple, which now is the largest component of a market-cap-weighted S&P 500 fund.

Another type of smart-beta fund is one that siphons out volatility, such as the PowerShares Low Volatility ETF (SPLV). By holding the stocks with the least volatility in the S&P 500, this fund allows more conservative investors to sleep just a little bit better at night.

The popularity of smart-beta funds of late has really been a notable trend in the market. In fact, approximately 60% of capital flowing into ETFs during the past couple of years has gone into some sort of smart-beta fund.

As the markets get harder and harder to navigate, and as opportunities to profit become increasingly more difficult to uncover, one area we’ll be looking to for future allocations is smart-beta ETFs. It’s a smart trend whose time has come.

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