Investors have the opportunity to comparison shop among the wide variety of exchange-traded funds (ETFs) based on smart beta methodology. Smart beta offers alternative indexing systems. Most ETFs track a capitalization-weighted index with an assigned percentage of index weight to each component, representing the security’s proportional share of the total dollar amount invested in all of the index components. Smart beta ETFs track equity indexes designed to rank stocks according to financial accounting metrics rather than stock prices. Many asset management companies have developed unique smart beta indexing methodologies, utilizing customized sets of metrics to assess the performances of component stocks.

iShares MSCI USA Quality Factor ETF

The iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL) tracks the performance of the MSCI USA Sector Neutral Quality Index. The underlying index consists of large- and mid-cap stocks with high scores based on three main factors: high return on equity (ROE), low leverage, or debt, and low variability of earnings growth. This ETF had a low expense ratio of 0.15% and a total net asset value (NAV) of $2.17 billion as of March 24, 2016. It experiences an average daily trading volume (ADTV) of approximately 206,000 shares.

After declining 10.39% during the January 2016 stock market slump, it was not until March 16, 2016, that this ETF closed above its Dec. 31, 2015, closing price of $64.26 per share. On Feb. 22, 2016, it closed above its 50-day moving average for the first time since Dec. 31, 2015. QUAL demonstrated a slightly stronger recovery from the early 2016 stock market pullback compared to the rebound by the SPDR S&P 500 ETF (NYSEARCA: SPY). By the market close on March 24, 2016, QUAL was 3.18% above its 200-day moving average, while SPY was just 1.77% above its 200-day line.

PowerShares FTSE RAFI US 1000 Portfolio ETF

The PowerShares FTSE RAFI US 1000 Portfolio ETF (NYSEARCA: PRF) is one of nine ETFs offered by PowerShares utilizing the fundamental indexing methodology developed by Rob Arnott’s firm, Research Affiliates. Arnott’s 2005 article “Fundamental Indexation," co-authored by Jason C. Hsu, and Philip Moore and published in the Financial Analysts Journal was the pioneering thesis on smart beta methodology. This ETF tracks the FTSE RAFI U.S. 1000 Index, the original smart beta equities index. The underlying index utilizes a system of weighting component stocks according to sales, cash flow, dividends and book value. PRF experiences an average daily trading volume of over 200,000 shares. It had total net assets exceeding $3.9 billion as of March 24, 2006.

After experiencing an 11.7% decline during the January 2016 stock market slump, PRF returned above its Dec. 31, 2015, closing price of $86.51 per share on March 11, 2016. On Feb. 22, 2016, it closed above its 50-day moving average for the first time since Dec. 29, 2015. On March 11, 2016, this ETF closed above its 200-day moving average for the first time since Dec. 1, 2015. PRF demonstrated a less-resilient recovery from the early 2016 stock market pullback compared to the rebound by SPY. By the market close on March 24, 2016, PRF was 1.33% above its 200-day moving average, while SPY was 1.77% above its 200-day line.

Comparing the Two Smart Beta ETFs

Based on recent performance, the 0.39% expense ratio for PRF is not justified when this ETF is compared to the QUAL ETF with its 0.15% expense ratio. Between March 24, 2015, and March 24, 2016, the share price for QUAL advanced 2.28%, while the share price for PRF declined 3.05%. The 50-day moving average for PRF has not been above its 200-day moving average since the Aug. 25, 2015, appearance of a death cross on its chart. The 50-day moving average for QUAL remained above its 200-day moving average from Nov. 24, 2015, through Feb. 4, 2016. Although QUAL made a slightly stronger recovery from the early 2016 stock market pullback, compared to the rebound made by SPY, PRF made a less-resilient recovery.

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