What is smart beta, anyway?
The term “smart beta” really started making the rounds heavily over the past few years, but it’s not some new type of fad fund. Really, smart-beta ETFs are simply exchange-traded funds that go beyond typical cap-weighted indices, instead considering factors such as income, value/growth or even technical momentum. It can be as simple as only tracking the dividend-paying stocks in the Standard & Poor’s 500 index, or even holding all an index’s stocks equally (as opposed to the usual market cap-weighted methodology of traditional indices). But smart beta also includes complex strategies with numerous spins that might sound niche, but create some serious outperformance.
iShares Russell 1000 Value ETF (ticker: IWD)
The largest smart-beta ETF by assets under management (just more than $37 billion) also shows one of the most classic forms of index manipulation: growth versus value. IWD and similarly focused funds take an index (in this case, the Russell 1000 index of mostly large-cap stocks) and only invest in those that are considered to be undervalued. No surprise, then, to see battered stocks like Exxon Mobil Corp. (XOM) and General Electric Co. (GE) in the top 10 holdings. IWD has been around since 2000, too — all the evidence you need that smart-beta strategies were hot long before the term ever was.
Expenses: 0.2 percent, or $20 annually per $10,000 invested.
Vanguard Dividend Appreciation ETF (VIG)
Dividend funds are another common form of smart-beta ETF, though the VIG takes it a couple steps further. For one, it tracks not just income payers, but companies that have improved their payouts annually for at least the past 10 years. It then caps the maximum weight of any security at 4 percent at rebalancing so no single stock has too much effect on the fund’s performance. Top holdings include Microsoft Corp. (MSFT), PepsiCo (PEP) and Johnson & Johnson (JNJ). VIG only yields 1.9 percent, but that’s largely because the focus on dividend improvement is more a measure of quality than a chase for high yield.
Expenses: 0.08 percent
Guggenheim S&P 500 Equal Weight ETF (RSP)
Some smart-beta ETFs invest in the same companies as a traditional ETF, but merely weight them differently. In the RSP, every S&P 500 component is weighted equally at every rebalancing. This has two benefits: One, it reduces single-stock risk — Apple (AAPL) currently makes up 3.6 percent of the S&P 500, but just 0.2 percent of the RSP. Two, it allows the ETF to generate more return from smaller companies with growth potential in the index. As a result, hot top holdings such as Wynn Resorts (WYNN) and Vertex Pharmaceuticals (VRTX) have far more influence over the RSP than they do traditional S&P 500-tracking funds.
Expenses: 0.4 percent
WisdomTree Europe Hedged Equity Fund (HEDJ)
Another smart-beta strategy is currency hedging, which, at its best, allows you to invest in a region’s growth without the drag of a weak currency. WisdomTree is one of the top specialists in this area, and its Europe-focused HEDJ is the largest such ETF. The HEDJ allows you to invest in the blue-chip stocks of 10 European countries such as France and Germany (and a few heavily Europe-exposed U.S. firms), but with minimal exposure to euro fluctuations thanks to currency forwards. In short, HEDJ is a great play on Europe when the dollar is strong — but not so much when the euro shows some muscle.
Expenses: 0.58 percent
PowerShares S&P 500 Low Volatility Portfolio (SPLV)
An increasingly popular angle over the past few years has been the low volatility fund — essentially a basket of stocks that should generate less beta (and thus, not move around as much) as the S&P 500, providing more peace of mind. PowerShares’ SPLV, for instance, invests in the 100 S&P 500 stocks that have demonstrated the lowest realized volatility over the past 12 months — at the moment, that includes stocks such as JNJ and 3M Co. (MMM). But SPLV takes an additional step to protect from volatility, equal-weighting its holdings to give no stock much more than a 1 percent grip on the fund’s performance.
Expenses: 0.25 percent
iShares Edge MSCI USA Quality Factor ETF (QUAL)
Some smart-beta ETFs go the route of Waffle House hash browns, where the provider layers a number of screens to produce what should be a superior portfolio. iShares’ QUAL is one of the biggest ($3.75 billion) and simplest examples on the market. QUAL invests in 125 stocks that boast positive fundamentals — “high return on equity, stable year-over-year earnings growth and low financial leverage.” The portfolio is top-heavy, with Altria Group (MO) at 7.4 percent and JNJ at 5 percent, but it works — as of this writing, QUAL has outperformed the S&P 500 by 630 basis points on a total return basis since July 2013.
Expenses: 0.15 percent
SPDR Russell 1000 Momentum Focus ETF (ONEO)
Momentum investing, in a nutshell, is simply chasing stocks that have outperformed for weeks or months. It’s a popular enough strategy that several ETFs are designed to harness it. SPDR’s ONEO considers value, quality and market cap in determining weighting, but tilts most heavily toward price outperformance over the prior 11 months. At the moment, top holdings are Best Buy Co. (BBY), HP (HPQ) and Symantec Corp. (SYMC). ONEO is a young fund that only got its start in late 2015, and so far, it moves similarly to the S&P 500.
Expenses: 0.2 percent
Guggenheim S&P Spin-Off ETF (CSD)
The CSD is a niche ETF that bets on the premise that corporate spinoffs “unlock” shareholder value. In some cases, corporate assets are simply valued less as part of the whole, but are more appreciated when they become their own publicly traded firms. In other cases, when businesses are split, they improve because management is able to better focus on their specific needs rather than balancing the many needs of a conglomerate. CSD invests in 66 stocks of companies that have been spun off in the past four years, which right now includes eBay (EBAY) spinoff PayPal Holdings (PYPL) and Pfizer (PFE) spinoff Zoetis (ZTS).
Expenses: 0.65 percent (includes 6-basis-point fee waiver)
VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
Smart-beta ETFs can include the bond world, too. For instance, VanEck’s ANGL is a twist on the tried-and-true junk debt fund. Rather than investing in just junk-rated bonds, this ETF invests in “fallen angels” — high-yield bonds that started off as investment-grade but were downgraded into junk status. These downgrades tend to still be high on the junk spectrum, making this fund’s portfolio slightly safer than many other high-yield bond funds (78 percent of ANGL’s holdings are BB, the top rating in junk). Granted, ANGL’s yield isn’t as robust as a result, but it still pays out roughly 5 percent.
Expenses: 0.35 percent (includes 30-basis point fee waiver)
PowerShares S&P 500 BuyWrite Portfolio ETF (PBP)
Lastly, smart-beta ETFs can get downright trade-happy — like the PBP, which is designed around options. The PBP is long the S&P 500 index, but uses a “buy-write” strategy (covered calls) to generate income. In this options strategy, you sell calls against stocks you hold for “premium.” If your stock stays below a particular strike price, you keep the stock; if not, it’s “called” away. This strategy works best with flat performance, helps protect against downturns, but also caps upside. That’s not good in an upmarket like this year, where the SPY has delivered more than 9 percent, yet PBP has returned just 4.9 percent.
Expenses: 0.75 percent
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10 Smart-Beta ETFs That Will Help You Get Your Alpha originally appeared on usnews.com
