Smart-Beta ETFs: The Risks You Want

March 06, 2014

In RSP’s defense, investors in the fund have taken more risk, but have enjoyed higher returns over one-, three-, five- and 10-year periods compared with the broad-market benchmark. (See our fund report for the numbers.) This is not-risk adjusted outperformance, but it’s still an impressive record of higher returns driven by the fund’s specific risks.

PRF’s risks are more subtle. The fund also favors smaller firms and carries higher market risk. PRF pulls from a broader universe of 1,000 stocks and not the S&P 500, so it has a natural bias toward smaller firms.

While PRF has less market risk than RSP, it takes bigger sector bets, favoring financials and skimping on tech plays.

Overexposure to a certain sector cuts both ways: Investors in the PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-47) saw its fortunes rise and fall in 2013, driven by its massive allocation to telecoms.

PRF also shows higher returns than the market over one-, three- and five-year periods. As with RSP, these are not higher-risk-adjusted returns, just higher returns and higher risk.

Lastly, it also makes sense to compare smart-beta ETFs to active mutual funds rather than comparing them with cap-weighted ETFs like SPY. Where an active mutual fund shares a strategy with a smart-beta ETF, the ETF offers the advantages of discipline, transparency, tax efficiency and low costs. At a minimum, the ETF can serve as an appropriate benchmark, if not an outright replacement to the active mutual fund.

Investors come in all shapes and sizes. Their investment products should, too. Investors who believe in a strategy like RSP and PRF are more likely to stay the course rather than sell off at the trough. This in turn might protect those investors from their own worst enemy: themselves.



At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected].


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