Todd Rosenbluth is director of ETF and mutual fund research at CFRA.
At the Inside Smart Beta & Active Summit last month, CFRA was asked during a panel discussion to make the case against smart-beta ETFs. We responded that keeping it simple using low-cost well-diversified, market-cap weighted ETFs such as the Vanguard 500 ETF (VOO) and iShares Core MSCI EAFE (IEFA) as building blocks of a portfolio will likely continue to result in strong relative performance compared to active mutual funds.
For those that want something extra, whether in the form of better potential returns or lower risk, it’s important to do the homework first.
During the Smart Beta conference, CFRA also conducted video interviews with other industry experts:. In his video, Dave Nadig, Managing Director at ETF.com, described the term smart beta as an umbrella for multi- factor ETFs as well as individual factor products such as value, momentum and quality.
But he explained that people get confused because, for example, value investment is something we’ve been doing for decades.
Not A New Concept
Indeed, the iShares S&P 500 Value ETF (IVE), launched in 2000, and the Eaton Vance Large Cap Value Fund (EHSTX), a mutual fund, came to market in 1931, though the management has shifted a bit since then.
However, a host of younger and sometimes cheaper index-based value ETFs have rolled out in the last three years, including the Fidelity Value Factor (FVAL), JPMorgan US Value Factor ETF (JVAL) and Vanguard US Value Factor ETF (VFVA).
Yet, CFRA agrees with Nadig that, as an investor or an advisor, you really need to dig beneath the surface and understand the ETF’s exposure.
Value Metric Can Vary
Some of the value ETFs referenced above are constructed with a sector-neutral approach and the rules-based index selects value stocks relative to sector peers. As a result, VLUE has a 26% weighting in the information technology sector, led by Apple (AAPL), and a 6% weighting in energy.
Other ETFs, including RPV, are also constructed based on value metrics, but ignore sector composition. RPV, for example, has just 3% in technology stocks, but 12% in energy issues including stakes in Andeavor (ANDV) and Valero Energy (VLO).
Despite distinct exposures, VLUE and RPV both earn CFRA top ratings based on our holdings-level analysis and fund metrics. For example, VLUE has a lower 0.15% net expense ratio than RPV’s 0.35%, but both trade with penny bid/ask spreads.
Investors should be careful timing factors, as Nadig explained. He pointed out that momentum was the best-performing factor in 2017, but in the past, it was the worst performer. So, if you are going to time factors, you need to have a pretty strong conviction about why now, according to Nadig. A more diversified ETF approach can reduce the risk of choosing the wrong factor to be overexposed to.
Laser Focused Exposure
Barry Ritholtz, chairman and chief investment officer of Ritholtz Wealth Management, a fast-growing financial planning and asset management firm, also did a video with CFRA at the Inside Smart Beta conference. He explained ETFs offer an inexpensive way for an advisor to get specific exposure to equity and bond styles. While his firm is a big believer in factor investing and has a value and small-cap tilt, he told us there are a lot different ways to get that exposure.
For example, Ritholtz said he is a fan of Dimensional Funds, which offers several dozen strong-performing equity mutual funds that use a systematic approach to investing—including DFA Small Cap Value Portfolio and DFA International Small Company Portfolio.
In the video, Ritholtz jokes he wakes up early and day-trades European futures, then explains with a straight face that he likes to own a broadly diversified portfolio and make changes when there’s a compelling reason to do so. Statistically speaking, the more active you tend to be as an investor the greater your odds are of making a mistake.
CFRA’s ratings on approximately 1,400 equity and bond ETFs are refreshed daily to reflect our latest views on the holdings, costs and more, and many advisor clients use the research to support strategic and dynamic asset allocation portfolios.
CFRA will be hosting a webinar on July 25 at 11am ET titled Active Mutual Funds vs. Index ETFs: 2018 Mid-Year Review & What’s Ahead.
At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him on Twitter @ToddCFRA.