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WHAT IS 'Intelligent ETF'

An intelligent ETF is an exchange-traded fund (ETF) that employs an active investment strategy based on a broad index, such as the S&P 500 or a sector-based index. The fund may choose to exclude some stocks within the index while increasing or decreasing the percentage weighting of other stocks. Most intelligent ETFs carry higher expense ratios than standard ETFs, as well as substantially higher turnover ratios.

An intelligent ETF is also known as a smart ETF. 

BREAKING DOWN 'Intelligent ETF'

An intelligent ETF is a type of exchange-traded fund (ETF) that is actively traded according to a set of rules that vary for each fund. Most regular ETFs are funds that mirror indexes, which means they tend to be weighted by market capitalization. This means that the bigger the stock is, the more it’s weighted in the ETF. While that sounds fine, what it means in practice is that overvalued stocks quickly become heavily weighted in an ETF, and when they burst, investors in the ETF lose more money than they would have if there hadn’t been so much weight in that overvalued stock. In essence, this market cap weighting creates a problem and then intensifies the problem it creates.

Intelligent ETFs mitigate this problem by creating a set of rules used to choose stocks for the fund and to weight them. These rules may be related to valuation of the stocks using internal metrics or black box systems, such as company fundamentals or share performance or some other factor. But they lessen the black swan effect of too much weight on an overvalued stock by forcing managers to take into account something other than simply market cap. Many of these "intelligent" or "smart" ETFs originated in the aftermath of the 2000-2002 bear market as a remedy to the overvaluation of this market.

Any ETF or index fund that does not replicate a base index is not passive investing, meaning that the fund's returns could deviate markedly from the returns of the benchmark index. Some intelligent ETFs have internal or proprietary indexes that are merely replicated within the ETF, but this is still active investing, and many of the internal indexes cannot be readily examined.

Artificial Intelligent ETFs

It could be argued that the logical next step in intelligent ETFs are artificial ETFs. Artificial ETFs are intelligent ETFs that are chosen and managed by computer programs that follow set rules and analyze funds to find the best performers within the constraints of the given rules. Since 2017 several different artificial intelligent ETFs have started and they are doing well against the rest of the funds market. The sheer number of stocks they are able to analyze gives them the advantage over traditionally-managed intelligent ETFs.

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