Best & Worst Smart Beta ETFs

Smart-beta ETFs have been all the rage recently, attracting billions of dollars in inflows. These funds, which often share little in common other than the fact that they aim to outperform traditional, market-cap-weighted index funds, are extremely varied in their strategies. Unsurprisingly, just as varied as their strategies is their performance.

Since the start of 2015, there have been both big winners and big losers in the smart-beta space. That said, the top-performing smart-beta ETFs so far in 2015 do share some commonalities. Nine of the 10 funds on the list are related to either health care, Japan or Europe.

These are the hot areas of the market to begin with, but some of these smart-beta ETFs even outperformed their plain-vanilla counterparts, which is what they strive to do.

Obamacare Boosts Health Care

Topping the list was the PowerShares Dynamic Pharmaceuticals ETF (PJP | B-82), with a return of nearly 23 percent through July. The fund is one of three health care ETFs in the top 10; the health care sector has benefited significantly from spending on "Obamacare," the government program that has insured millions of Americans.

In contrast to the typical cap-weighted approach, PJP weights its constituent companies by various fundamental and risk factors. That's given the fund a greater tilt toward small- and midcaps compared with a vanilla fund such as the iShares U.S. Pharmaceuticals ETF (IHE | A-69). PJP's methodology has enabled it to outperform IHE, which has returned a still-impressive 20.4 percent this year.

The other two health care names on the list are the PowerShares DWA Healthcare Momentum ETF (PTH | B-46) and the PowerShares Dynamic Biotech & Genome ETF (PBE | B-52), with gains of 20 percent and 18.7 percent, respectively.

PTH's momentum strategy, in which it selects its holdings based on relative strength and price momentum, handily outperformed other broad-based health care ETFs, such as the Health Care Select SPDR (XLV | A-94), with a 20 percent return versus 12.7 percent for XLV.

Meanwhile, in a case where the smart-beta ETF underperforms, PBE significantly lagged the return of the cap-weighted biotech sector heavyweight, the iShares Nasdaq Biotechnology ETF (IBB | A-44), with a mere 18.7 percent gain versus 26 percent for IBB.

In contrast to the biotech benchmark, PBE includes companies in the nascent genome industry, and uses a multifactor system to select which stocks to hold.

Japan Top Country

While health care ETFs have been stellar performers in the U.S., the country as a whole hasn't fared too well. In fact, the U.S. stocks are sharply underperforming other regions of the world this year, particularly the top-performing country so far in 2015, Japan.

Four smart-beta ETFs linked to Japan are on the top 10 list, including the Wisdom Tree Japan Hedged Small Cap Equity ETF (DXJS | B-57) and the WisdomTree Japan SmallCap Dividend ETF (DFJ | B-93).

As its name implies, DFJ holds small-caps, while placing a greater emphasis on dividend-paying stocks. DXJS holds essentially the same portfolio but hedges out the currency exposure. So far this year, the currency-hedged DXJS outperformed its sister fund DFJ as the Japanese yen depreciated against the U.S. dollar.

At the same time, both ETFs outperformed standard Japan small-cap funds like the iShares MSCI Japan Small-Cap (SCJ | B-99), which rose by 14.7 through July compared with 20.1 percent for DXJS and 17.6 percent for DFJ.

Another Japan ETF that outperformed on the back of favorable currency movements was the WisdomTree Japan Hedged Equity ETF (DXJ | B-66), an extremely popular fund that holds a basket of dividend-weighted and export-oriented stocks.

DXJ's smart-beta strategy gave it the edge over the also-popular iShares MSCI Japan ETF (EWJ | B-99), with a 17.3 percent gain compared with EWJ's 15.6 percent.

The final Japan fund to make the top-performers list was the iShares MSCI Japan Minimum Volatility ETF (JPMV | B-80), with a 17.1 percent return. The fund, which pulls companies from the same MSCI index as the aforementioned EWJ, adjusts its positions with an eye toward reducing risk by choosing stocks with low volatility and low correlations with each other.

QE Fuels Upside In Europe

Like Japan, Europe has been another strong region for markets in 2015 thanks to the European Central Bank's unprecedented quantitative easing program that began this year. The WisdomTree Europe Hedged Equity ETF (HEDJ | B-48) was one of the best-positioned ETFs to take advantage of that strength, as it returned 17.2 percent through the first seven months of the year.

HEDJ is essentially the Europe version of the popular Japanese fund DXJ, and also focuses on export-oriented firms. Also like DXJ, the fund hedges currency exposure; thus, this year's 9 percent decline in the euro has allowed HEDJ to outperform the cap-weighted behemoth, the iShares MSCI EMU (EZU | A-76), which only rose by 8.4 percent so far this year.

The WisdomTree Europe SmallCap Dividend ETF (DFE | C-86) was another winner, with a 15.9 percent gain. DFE is comparable to the aforementioned DFJ, the dividend-focused Japanese small-cap ETF.

Nasdaq Momentum Strategy

Rounding out the top 10 is one outlier, the PowerShares DWA Nasdaq Momentum ETF (DWAQ | B-46) with a 15.9 percent return. DWAQ's strategy of holding Nasdaq-listed stocks with strong price momentum was a winner so far this year, besting the cap-weighting scheme of the Fidelity Nasdaq Composite Tracking Stock (ONEQ | A-70), with a 9.2 percent return, as well as broader-stock-market ETFs, which were only up by single-digit percentages.

Commodities Fuel Poor Performance

Just as the top-performing smart-beta funds of 2015 shared some similarities, so too did the bottom-performing funds. In fact, each of top 10 worst-performing ETFs shares one characteristic: They are commodity-related.

From energy to precious metals to soft commodities, smart-beta ETFs linked to a number of commodity sectors made an appearance on this list. That said, energy-related ETFs were at the bottom of the barrel, taking up seven of the 10 spots.

Energy Drops Across The Board

Far and away the worst-performing ETF was the First Trust ISE-Revere Natural Gas Fund (FCG | A-99) with a 38 percent loss. The fund is the only exchange-traded product that offers access to predominantly natural gas equities, and it does so using an equal-weighting scheme. Unfortunately, with natural gas prices in the tank amid oversupply concerns, the underlying stocks have been hammered, making FCG a standout loser.

Other smart-beta energy ETF laggards include the PowerShares DB Oil (DBO | B-88), which tracks crude oil futures while optimizing contracts to minimize contango; the First Trust Energy AlphaDex (FXN | B-54), which uses a proprietary quant-based approach to weight its energy stock holdings; and the PowerShares Dynamic Oil & Gas Services ETF (PXJ | C-20), which uses a multifactor approach to select which oil services stocks to hold.

None of these smart-beta strategies did much to staunch the bleeding due to oil prices. The optimized DBO, for example, performed just as poorly as the vanilla United States Oil Fund (USO | B-100).

At the same time, FXN performed much worse than the broad-based Energy Select SPDR (XLE | A-95) and PXJ significantly underperformed the cap-weighted Market Vectors Oil Services ETF (OIH | A-47). Much of the underperformance in the smart-beta products can be tied to the fact that they are tilted toward smaller companies, which tend to underperform in a down market.

Miners & Brazil Share Hit Hard

Outside of energy, the big loser in 2015 so far was gold miners. And out of that dreary bunch, the Sprott Gold Miners ETF (SGDM | B-71) was the poorest performer. Unlike the Market Vectors Gold Miners ETF (GDX | C-77), which ranks its holdings based on market cap, SGDM selects them based on their beta against spot gold prices. That makes the portfolio even more volatile than the already-volatile sector benchmark.

SGDM lost 27.7 percent through the first seven months of the year compared with 25.2 percent for GDX.

One standout on the list that isn't directly linked to commodities, but nonetheless is heavily impacted by them, is the First Trust Brazil AlphaDex (FBZ | F-79). Brazil is, of course, one of the largest commodity producers in the world, supplying significant volumes of coffee, oil, iron ore and more.

While that was good for FBZ during the commodities boom, it's been all bad news during the current bust. The ETF, which uses a proprietary methodology to weight its holdings, has underperformed the cap-weighted behemoth in the Brazil space, the iShares MSCI Brazil Capped ETF (EWZ | B-95) with a loss of 23.1 percent compared with EWZ's 20.1 percent.

Contact Sumit Roy at [email protected].