'Smart Beta' 6: A Better Definition

May 21, 2014

In a world without 'smart beta,' strategy is king.

This blog is the sixth installment of a series transforming our ideas about "smart beta." Part 1 started with the proposition that defining smart beta in an ETF context is essentially impossible. Part 2 laid out the ground rules to prove the point; Part 3 sunk noncap weighting as a method to categorize smart beta; and Part 4 took a wrecking ball to the notion that factor-focused tilts were synonymous with smart beta. Part 5 examined the dearth of real risk-adjusted outperformance in the realm of smart beta.

In my last blog, after I demolished your hopes of defining "smart beta," I promised constructive suggestions for how best to describe complex index strategies.

So, here's my oh-so-radical solution: Let's leave behind marketing labels and talk about what funds actually do.

Instead of talking about "smart beta," with all the baggage of errant factor exposure and missing excess risk-adjusted returns, let's talk about the exposures the fund targets, and the process by which it gets there. Let dividend funds be dividend funds; let value be value; let momentum be momentum; and low volatility be low volatility.

Let's talk instead about a fund's strategy.

ETF.com's ETF Finder tool has three fields to help you understand a fund's geographic footprint, and three more that drill down into its market segment. But up to now, we haven't been very clear about investment strategy.

We've always had the fields I discussed in Blog 3—selection and weighting—that describe the process by which an index narrows and reweights its investment universe. But it's awkward to use these as filters.

Issuers sometimes add to the confusion with misleading fund names. The wildly popular WisdomTree Japan Hedged Equity Fund (DXJ | B-55) hides its dividend-paying exporter focus behind a vanilla-sounding name. Would you ever guess that the Vident International Equity ETF (VIDI | D-51) weights securities within each country by balancing expected tail-loss metrics and then weights each country according to macroeconomic factors, price/earnings ratios, momentum, and fundamental metrics?

ETF investors deserve better.

So today I'm introducing a new field: "strategy."

Vanilla is a strategy. So are equal weighting, fundamental analysis, duration hedging and commodity futures optimization. Even price weighting is a strategy, albeit an antiquated one.

Strategy gets at the heart of how a fund is built, because we base it on index construction methodology. Strategy cuts away the marketing hype and describes what a fund or an index actually does.

ETF.com has developed a strategy tag for every U.S.-listed equity, fixed-income, commodity and currency ETF, including levered and inverse funds. Want to count the dividend-focused funds, or the buy-writes, momentum-seekers or plain-vanilla funds? No problem.

Here's a list of the 27 strategies we've identified.

Active Duration Hedged Momentum
Bullet Maturity Environmental, Social & Governance (ESG) Multifactor
Buy-write Equal-weighted Optimized commodity
Copycat Exchange-specific Price-weighted
Currency-Hedged Dividends Fundamental Target Duration
Currency-Hedged Fundamental Growth Time Since Launch
Currency-Hedged Vanilla High Beta Value
Depositary Receipts Laddered Vanilla
Dividends Low Volatility Volatility Hedged

You can find strategy definitions at the end of this blog.

Strategy assignments are completely rules-based, in keeping with our ETF classification methodology. Write to me at [email protected] if you'd like a copy of the strategy rulebook or a download of each fund's strategy assignment.


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