Smart beta represents a significant portion of the overall exchange-traded funds (ETFs) landscape, both in terms of assets and population. In 2017, smart beta ETF assets once again topped records and today there are approximately 1,000 such products trading in the U.S. The total universe of U.S.-listed exchange-traded products (ETPs) is over 2,200, meaning fundamentally weighted funds are a sizable percentage of the U.S. ETF market.

While the ETF industry is increasingly competitive, investors should expect more, not less, when it comes to smart beta launches. In fact, hundreds of the existing fundamentally-weighted funds trading in the U.S. are not three or five years old. With the smart beta space expanding at a rapid pace, investors should focus on certain traits when evaluating these ETFs.

“The best strategic-beta funds are cheap, transparent, effectively capture the factor(s) of interest, and take steps to mitigate unnecessary turnover and risk, such as large sector or country concentration,” wrote Alex Bryan, CFA, Director of Passive Strategies Research, North America at Morningstar.

Smart Beta Fees

Broadly speaking, smart beta ETFs carry higher expense ratios than their cap-weighted counterparts. Most U.S.-listed smart beta ETFs have annual fees of over 0.4% per year and even the 100 or so largest such funds have fees of just over a quarter of percent up to about 0.33%.

“Strategic-beta funds tend to charge more than traditional index funds, but investors shouldn't pay a high premium for them,” wrote Bryan in a Dec. 27 blog post. “These are rules-based strategies that do not require any more human intervention than an S&P 500 tracker. Fortunately, many strategic-beta funds charge less than 0.30%, which is competitive with the lowest-cost index funds.”

Fortunately for investors, the fee that has been so prevalent in the cap-weighted space has made its way to smart beta. In 2017, issuers either pared fees on smart beta ETFs or brought new, low-cost options in the category to market. For example, in November, JPMorgan Asset Management, introduced several new smart beta ETFs, including growth, value and dividend funds, all with fees of just 0.12% per year.

Multi-Factor Advantages

As has been widely noted, multi-factor ETFs are a growing part of the broader smart beta space. There is a runway for that growth because more advisors and investors are realizing timing individual investment factors is difficult

For example, growth and momentum are leading in 2017 while value stocks are lagging. That has many market observers betting value will rebound in 2018. However, that does not mean growth and momentum will suffer. ETFs, such as the JPMorgan Diversified Return U.S. Equity ETF (JPUS), which emphasizes several factors under one umbrella, ensure investors are not chasing performance with factors while remaining diverse across the factor stage.

“Not all strategic-beta funds are worth investing in, but the ones that are offer transparency, sensible portfolio construction, and reasonable fees,” notes Morningstar. “Even the best strategies won't work all the time. Diversifying across factor strategies can help reduce risk and make it easier to stick with them over the long term, which should improve the odds of success.”

 

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