Smart Beta ETFs Get Even More Popular

Brown Brothers Harriman study finds investors are now looking at them as defensive plays.

Smart beta is in vogue as an investing style lately, with numerous new investment vehicles crowding into the space. And the big impetus appears to be smart beta’s superior ability to weather a rough market.

That’s the conclusion of a Brown Brothers Harriman study of exchange-traded funds (ETFs) specializing in smart beta, which also is known as fundamental investing. As the study pointed out, “Most (70%) of smart beta ETF users are searching for risk mitigation or volatility control, suggesting some may be positioning portfolios for a turbulent year in 2019.”

Smart beta substitutes metrics like dividend yield, earnings, and book value to come up with supposedly improved versions of the market value method, traditionally followed by stock indexes. The rap on the S&P 500, the mother of market cap measurement, is that the biggest winners tend to skew the index. And this tendency has been particularly acute over the past year, when Apple and other FANG stocks have dominated the S&P (pulling it up, then in December, yanking it down).

According to BBH’s analysis, investors once went for smart beta as a way to achieve alpha, or market-beating returns—but now they view this group as more of a defensive play.

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Not that they are forgetting about smart beta’s allure as a supposed alpha generator. Tellingly, one-third of the new investments in smart beta ETFs is flight money out of actively managed funds. Small wonder: Active funds have turned in yet another stinko performance trying to do better than the traditional S&P 500. This implies that these folks still thirst for above-market outcomes.

Then there is the fees question. While the BBH study didn’t cover this aspect, the fees for smart beta ETFs are about half of what actively managed funds charge. A late-2017 Morningstar study of the field found that smart beta ETFs averaged 0.37% in yearly fees. And as the research firm noted, the expenses are going down, so it doubtless is even more affordable today.

Another question is how well the smart beta products perform. Investment manager Barry Ritholtz, writing for Bloomberg Opinion, compared the Invesco FTSE RAFI US 1000 Portfolio, which follows a smart beta strategy, with the Russell 1000, from 2005 to last summer. He and his firm concluded that the smart beta product came out slightly ahead.

Nonetheless, smart beta—hey, the name itself is a big advertisement, which is why Morningstar prefers to call it strategic beta—has attracted a big following. Numerous fund houses have launched their versions. Say what you want, this is no mere fad.

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