Todd Rosenbluth is director of ETF and mutual fund research at CFRA.
Last week, CFRA spoke at the Inside Smart Beta conference in New York hosted by Inside ETFs. The term “smart beta” is widely used, but disliked by many in the industry.
There have been attempts to rename it “strategic beta,” or “alternative beta,” among many other names. Yet smart beta remains, and various strategies seem to fall into this group, despite the notable differences.
Rules-Based, But Different Weighting
In contrast to market-cap-weighted ETFs, such as the top-rated iShares Russell 1000 Index (and the Vanguard S&P 500 Index), built based on the market value of the holdings, smart-beta ETFs are different. These are also index-based strategies, but they use fundamental and/or price movement screens to offer a more targeted portfolio, and are reconstituted at predetermined times following a transparent rule book.
Yet smart-beta ETFs generally have different top holdings than the diversified S&P 500 or Russell 1000 indices, and the performance records of these alternatively constructed portfolios are quite distinct from each other.
Returns Can Vary Widely
For example, the iShares Edge MSCI U.S.A. Momentum Factor (MTUM) focuses on stocks that have exhibited recent relative strength. Year-to-date through June 7, MTUM has outperformed VOO and IWB, as many of last year’s winners, such as Amazon.com, Boeing and Intel, have climbed even higher in 2018.
MTUM was up 10% this year and has approximately 70% of assets in the pro-cyclical consumer discretionary, information technology and industrials sectors (VOO and IWB have approximately 50% in these sectors). Meanwhile, defensive real estate and utilities sectors comprise a combined 0.3% of the fund.
In contrast, the Invesco S&P 500 Low Volatility ETF (SPLV) was down 0.6% this year and has significantly more exposure to the defensive sectors. Utilities (24%) and real estate (13%) stocks, such as Duke Energy and AvalonBay Communities, are well-represented. SPLV holds the 100 least volatile stocks in the S&P 500 measured by standard deviation and is rebalanced quarterly, so many of the holdings have not had momentum on their side.
Both MTUM and SPLV were recent CFRA Focus ETFs of the month. However, these are yin and yang examples of what the ETF industry has come to consider as smart beta.
Further complicating matters for investors, iShares offers a U.S. minimum-volatility ETF, and Invesco offers multiple momentum-based ETFs. In addition, other asset managers—such as Fidelity, J.P. Morgan and SSGA—offer competing ETFs that hold either low-volatility stocks or high relative strength positions, but that track different indices, and as such, have different records.
Another of our top-rated ETFs, the Xtrackers Russell 1000 Comprehensive Factor ETF (DEUS) tracks an index that combines momentum and low volatility with quality, low size and value characteristics. DEUS was up 2.6% year-to-date, and like MTUM, its highest sector weightings are in consumer discretionary, industrials and technology.
However, the pro-cyclical trio is approximately 50% of the portfolio, while real estate and utilities are 14% combined. DEUS and peer multifactor ETFs offered by Goldman Sachs, John Hancock, Oppenheimer and others provide a more diversified approach for investors seeking a smart-beta offering.
Indeed, DEUS looks more like VOO and IWB from a sector level than MTUM or SPLV, but Apple is one of its smallest positions. Instead, Corning and eBay are among its larger tech positions.
Source: CFRA, June 7, 2018
We regularly hear from advisors—and are sure they hear from clients—asking for a favorite smart-beta ETF. That’s understandable: Many investors want a different outcome than the simple and often-boring choice of using VOO or IWB.
During one of the Inside Smart Beta panels CFRA in which participated, we were asked to make the case against using a smart-beta ETF. We responded that keeping it simple and using a low-cost, well-diversified and market-cap-weighted ETF makes sense for many investors. However, for those who want to seek higher returns or lower their risk profile, a different approach can make sense.
But digging into the holdings and the approach is important. CFRA’s research and ratings can help. To rate more than 1,100 equity ETFs, CFRA combines forward-looking holdings-level analysis with fund attributes, such as expense ratio and trading costs.
We don’t prefer market-cap-weighted or otherwise-constructed ETFs; rather, we look at each ETF relative to one another seeking the best portfolio investments in a low-cost, liquid wrapper.
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.