[This article appears in our June 2019 issue of ETF Report.]
Smart beta ETFs have proliferated like wildfire across the ETF universe. Depending on how broad a definition you use, there could be more than 1,000 such funds currently listed on U.S. exchanges.
This hasn’t just happened by chance. There’s tremendous demand for smart beta strategies, with investors of all stripes buying these funds.
There are many reasons investors may want to consider smart beta ETF strategies in their portfolios. But perhaps the biggest reason is the most straightforward—the possibility of better returns. Investors want to outperform market-cap-based indices, and they believe smart beta can help them do that.
The possibility of outperformance is also the main selling point smart beta ETF issuers use to market these products, and at least to some extent, the academic research backs them up.
Some Factors Outperform
According to index provider MSCI, a factor is simply any stock characteristic “that can be shown to be important ... in explaining risk or returns.” There could be thousands of factors, but only a handful have proven to outperform the broader stock market over long periods of time, including value, low size, momentum, low volatility, dividend yield and quality.
That said, the research is clear: Not all smart beta ETF strategies will outperform, and even for those that do, it’ll take a long enough investment time horizon to capture that potential outperformance.
It’s in that context that readers should interpret the rest of this article, where we lay out the historical returns of various popular smart beta ETFs compared with their market-cap-weighted counterparts. Just because a certain strategy is doing well or poorly in a particular arbitrary time frame doesn’t mean it’ll continue to do so going forward: Factors perform and underperform in cycles.
Moreover, this article only contains a sampling of the plethora of smart beta ETFs out there. These are among the most widely owned funds in the space with the largest amount of assets, but there are hundreds of others we don’t touch on. Without further ado, here are the results ...
Value ETFs are hands-down the most popular smart beta ETFs. It helps that this factor is considered one of six that’s historically outperformed the broader market over long time periods, according to MSCI research.
But the long time period the research measures and the shorter time period various value ETFs have been in existence are different, so it’s no guarantee ETF investors have seen this outperformance. Keep in mind each value ETF is different in the way it captures the factor. Some use price-to-earnings ratios, some use price-to-sales ratios, some use book values … the list goes on.
The Vanguard Value ETF (VTV), with $48.3 billion in assets, the iShares Russell 1000 Value ETF (IWD), with $33 billion in assets and the iShares S&P 500 Value ETF (IVE), with $15.4 billion in assets, are the three largest U.S.-listed value ETF on the market today.
Figure 1 shows the returns for these three funds since inception, along with the returns for their market-cap-based counterparts in the same time period.
As you can see, the time period measured and the ETF in question play a bit part in determining whether a factor has outperformed or underperformed.
IWD handily beat its market-cap-based counterpart, returning 251.5% since inception, compared with 208.6% for the iShares Russell 1000 ETF (IWB). IWD was aided by the fact that it launched in the year 2000, during the peak of the dot-com bubble, when value stocks were relatively cheap and the broad market was filled with high-flying, overvalued tech stocks.
The iShares S&P 500 Value ETF (IVE) got the same benefit of launching in the year 2000, and thanks to that, has outperformed the SPDR S&P 500 ETF Trust (SPY) for much of its existence. But recently, as value stocks have fallen out of favor, SPY has caught up with IVE, erasing nearly all of that outperformance.
Meanwhile, the largest value ETF, the Vanguard Value ETF (VTV), which launched several years after IWB and IVE, followed a completely different trajectory than its rivals. The dot-com boom and bust had no bearing on VTV, while the recent underperformance of value stocks is weighing on the fund. Currently, VTV’s lifetime return lags its counterpart quite substantially.