The “smart-beta movement” in ETFs has gone from a sideshow to a juggernaut in recent years. We’ve seen a rash of new issuers, strong net inflows and advisors of all sorts adding smart-beta exposure to their portfolios.
The predictions for future growth are extreme. In May of this year, BlackRock predicted that smart-beta ETF assets would reach $1 trillion by 2020 from their current level of $282 billion. That’s a 37% compound annual growth rate over four years. The amazing thing is, hardly anyone flinched at the number.
But the growth of smart-beta strategies in the ETF market is hardly new. ETF.com Editor-in-Chief Drew Voros asked me to identify “fewer than 10” ETFs that charted the course of smart-beta growth since the industry’s inception. And while that’s an impossible task—there are at least 20 deserving candidates—I agreed to describe nine among that list that are deserving.
Smart-Beta ETF No. 1: iShares Russell 1000 Value ETF (IWD | A-88)
AUM: $29 Billion
Expense Ratio: 0.20%
Why: Among The First Real Smart-Beta ETFs
People argue about what does and does not constitute a smart-beta ETF. To my mind, there’s a (slim) argument to be made that the very first ETF—the S&P 500 SPDR (SPY | A-97)—is a smart-beta ETF. After all, the origins of smart-beta investing trace their roots back to the work of Fama and French, who first argued that the returns of a stock could be explained by its exposure to three factors: 1) the market; 2) the size factor (large- versus small- cap stocks); and 3) the value factor (price-to-book ratio). As a large-cap ETF, SPY takes deliberate exposure to large-cap stocks.
That kind of argument can get you laughed out of Quantitative Work Alliance for Applied Finance, Education, and Wisdom discussions, however, as most investors use SPY as a proxy for “the market.” That leaves us with the iShares Russell 1000 Value ETF (IWD | A-88), which launched in May 2000 and is among the first ETFs with deliberate exposure to the value factor. While value isn’t as hip as nouveau factors like “low volatility,” it’s perhaps the most consistent and established factor for investors looking for long-term excess returns.
Consider this: Since inception, IWD has outperformed the iShares Russell 1000 ETF (IWB | A-94) by about 60%. Pretty smart indeed.
Smart-Beta ETF No. 2: PowerShares Dynamic Market Portfolio (PWC)
AUM: $141 Million
Why: Proved ETF Investors Want To Beat The Market
While IWD was among the first, the PowerShares Dynamic Market Portfolio (PWC | B-73) is, to my mind, one of the most groundbreaking ETFs in the evolution of smart beta.
Prior to the launch of PWC in 2003, ETFs were about tracking the market. Funds like SPY were used to equitize cash and gain exposure; they were, as people might call them today, “dumb beta.”
PWC promised something different. With a bold 0.60% expense ratio, PWC shocked the world by promising to beat the market, using a multifactor model to flesh out the stocks that would outperform.
And for a while, it worked. The fund easily surpassed its market-cap peers in the first few years after inception, earning a five-star rating from Morningstar at its three-year anniversary. At that point, it led the market by 7% since inception.
Big assets followed into both PWC and the broader PowerShares suite, which pulled in more than $6 billion in its first three years on the market. And while the fund’s performance eventually tailed off—it now trail20s the S&P 500 since inception—PWC’s success put PowerShares on the map, and proved outperformance could be sold in the ETF space just as it was in mutual funds. That realization launched a thousand more ETFs, and set the stage for the boom we see today.