Trading Lesson: What You Should Know about Smart Beta Index ETFs

Focus: FUNDS

Steven Pomeranz Image Steven Pomeranz Host, The Steve Pomeranz Show

Smart beta ETFs have lower fees and higher volume capacity than traditional active strategies. They offer the best of both worlds, writes Steve Pomeranz, CFP. Look for guides on how to get started trading or investing every Friday on MoneyShow.com.


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Today, I plan to talk about smart beta ETFs, the next wave of financial innovation that’s changing the way index funds (ETFs) are structured. But before I do that, let’s go back in time to how index investing got started.

In 1960, two students at the University of Chicago came up with the idea of an “unmanaged investment company” and laid out their model for an index fund.  While their idea did not gain much traction back then, it set the stage for a major innovation in asset management—the world of index funds. A decade later, in 1973, Burton Malkiel, an economist at Princeton University who wrote the best-selling classic A Random Walk Down Wall Street, told the public what Wall Street already knew: that most mutual funds do not beat market indexes.

Specifically, Malkiel wrote: “What we need is a no-load, minimum management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch the winners.”

A few years later, in December 1975, the young founder of the Vanguard Group, John Bogle, started the first index investment trust which tracked the S&P 500 Index (SPX), earning contemptuous jeers from Bogle’s peers who called the fund “Bogle’s folly.”  Even Fidelity Investments’ then-Chairman, the renowned Edward Johnson, said: “He couldn’t believe that the great mass of investors is going to be satisfied with receiving just average returns.”

But, as they say, the rest is history.  According to Vanguard’s website, Bogle’s index fund, which started out with $11 million in assets, has grown to about $560 billion in assets as of June 2017 and has delivered an average annual return of 11% since its inception, with an expense ratio of 0.14%, which is 86% lower than funds with similar holdings…pretty amazing!

Buffett’s ringing endorsement of index funds

The logic of this investing has not been lost on one of the greatest investors of our day, Warren Buffett.

 
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