It's a small niche getting big attention.
So-called smart beta exchange traded funds promise investors
higher returns or lower risk relative to a standard benchmark
such as the S&P 500. To achieve this, fund managers screen
stocks based on measures ranging from growth and value to
momentum and volatility and eschew the standard index-building
tools of market capitalization (S&P 500) or price (the Dow
It's more than a purely passive investing approach, less than
active management. So expense ratios tend to be lower than among
actively managed funds.
Although smart beta ETFs have been around for roughly 14
years, demand has surged recently. They are increasingly drawing
the mom-and-pop crowd
investing in stocks
Assets in smart beta ETFs totaled $335.5 billion at the end of
July, up 26% from July 2013, according to Morningstar Inc.
"This is a category that has been punching above its weight,"
said Ben Johnson, director of passive funds research, in a May
report. He noted that the 342 smart beta funds in the U.S. stock
market in 2013 accounted for 18% of total industry assets that
year but 35% of net inflow.
Now, on the heels of success, come analyst concerns. Some
critics contend that smart beta funds often deliver less than
promised, may not efficiently track their indexes and have
In serial blogs earlier this year, ETF.com analyst Elisabeth
that the category could not even be properly or consistently
Kinder, Gentler Strategic
Even Morningstar's May report urged a name change: to
strategic beta. Johnson wrote that this alternate terminology
emphasized strategic objectives, without implying traditional
indexing is dumb.
Still, "smart beta" has marketing zing. Compass EMP Funds used
the term in July to announce three new ETFs.
For Stephen Hammers, Compass' chief investment officer, his
smart beta methodology gives investors better returns with a
little less risk. At the same time, he notes, it offers better
diversification than cap-weighted indexing.
Compass' ETFs track proprietary volatility-weighted indexes.
So investors in the U.S. 500Volatility Weighted Index (
) own the 500 largest U.S.-based companies screened for
profitability and weighted by the volatility, or risk, of
"Our indexes beat 97% of active mutual funds in the last 10
years ending June," Hammers said.
Compass ETFs now have $28.8 million in assets.
Unlike traditional passive indexing, most smart beta
use a fundamentally weighted method. Smart beta leader WisdomTree
weights stocks based on their earnings or dividends.
The strategy is paying off for WisdomTree. Net inflow soared
from $1.4 billion in 2006 -- the year WisdomTree ETFs debuted --
to $14.3 billion last year.
The company's 69 ETFs had a combined $34.8 billion in assets
as of July.WisdomTree SmallCap Earnings (
) rebalances once a year. The weightings of its 800 component
stocks are adjusted based on their profits, which helps to lower
the fund's price-earnings ratio, says Luciano Siracusano, chief
investment strategist at WisdomTree. In the past five years, the
fundamentally weighted EES returned an average annual 18.02% vs.
the cap-weighted iShares Russell 2000's (