Cheap Matters With Smart Beta ETFs, Too

Fees on exchange-traded funds (ETFs) are falling, and that theme is not confined to plain vanilla, cap-weighted funds. Smart beta funds are also becoming less expensive. By some estimates, the average U.S. large-cap smart beta ETF carries an annual expense ratio of 0.35%, or $35 on a $10,000 investment. Factor ETFs, including those focusing on growth and value stocks, often carry fees that are well below average in the smart beta category. Those fees matter over time, particularly as investors wait for value stocks to rebound after trailing growth and momentum names in 2017.

"The average large-cap value mutual fund rose 15.8% in 2017, but still lagged the 17.2% return for the $37 billion Vanguard Value Index ETF (VTV), the large-cap value index ETF with the most assets," said CFRA Research Director of ETF and Mutual Fund Research Todd Rosenbluth in a note out earlier this week. "Part of the performance differential stems from VTV's 97 basis point lower expense ratio than the average large-cap value mutual fund. However, stock selections also contributed as the active managers collectively failed to spot enough 2017 strong performers." VTV, which is one of the largest smart beta ETFs of any variety, charges 0.06% per year. (See also: A Look Inside the Vanguard Value ETF.)

Of the 20 largest smart beta ETFs, six are value funds. Over time, low fees on value index funds and ETFs can be advantageous for investors. While VTV is among the cheapest value ETFs, some rival funds have slightly higher fees but are still worth considering and are still significantly less pricey than actively managed value funds. That group includes the iShares Edge MSCI USA Value Factor ETF (VLUE), which charges 0.15% per year. VLUE gained nearly 23% last year, putting it well ahead of actively managed rivals.

"VLUE holds the most attractively valued stocks in each sector and is more diversified than most value strategies. But to keep the value focus, it is rebalanced semi-annually, most recently at the end of November," said Rosenbluth. "International Business Machines Corporation (IBM) was one of the 16 additions and joined Apple Inc. (AAPL) and Intel Corporation (INTC) as large-cap technology constituents; assessing likely future prospects of underlying holdings is one way CFRA's proprietary ETF rankings provide a forward-looking perspective, unlike any other ETF ranking methodology."

The $3.3 billion VLUE tracks the MSCI USA Enhanced Value Index and has a three-year standard deviation of 11.6%. VLUE is a departure from traditional value funds because the iShares product features an almost 24% weight to technology stocks and a 12.4% allocation to consumer discretionary names, sectors that are usually hallmarks of growth and momentum funds. (For more, see: A Direct Approach to Value Stocks.)