What Are Smart Beta ETFs?

| January 31, 2014 | 0 Comments

market-cap-weightingThe biggest buzz around the world of exchange traded funds is ‘Smart Beta ETFs’.

What are these catchy sounding ETFs?

Let’s start from the top.  Beta is a term that refers to how much risk an individual stock or portfolio of stocks has compared to the market. 

Smart Beta strategies imply they are more intelligent than the market.  By using alternative ways to look at the market, they claim to be able to generate better returns.

In reality, a Smart Beta ETF is essentially any ETF that uses any stock picking and weighting methodology other than market-cap weighting.

Market-cap weighting or capitalization-weighted indexing weights each individual stock according to its market cap.  This gives larger companies a larger percentage weighting.   

Obviously, market-cap weighting is well known.  Most of the closely watched indices like the S&P 500 are market-cap weighted.

As the ETF industry has grown over the years, providers like iShares, State Street, and Vanguard have locked up the market-cap weighted ETF business. 

New entrants looking to make a splash in the ETF world have turned to a variety of different strategies to draw investor interest.  Smart Beta is simply another attempt by upstart ETF providers to pull money away from the bigger providers.

Here’s the thing…

Not all Smart Beta ETFs are alike.  For instance, I like the line of equal-weight ETFs from Guggenheim.  This weighting methodology isn’t complicated.  These ETFs simply invest an equal amount into each stock and periodically rebalance.

Equal-weighting address the issue of mega caps like Apple (AAPL) having too much influence on your ETF investments.

However, other Smart Beta ETFs come with serious drawbacks.  They often come with much higher expenses than traditional ETFs.  They often have more risk than investors understand.  And they can have long periods of underperformance.

Here’s the upshot…

Smart Beta ETFs are a natural progression as new ETF providers seek to gain a foothold in the lucrative world of ETFs.  They can be a valuable resource for investors.  But make sure you understand what you’re investing in and what the costs are.   

Good Investing,

Corey Williams

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Category: ETFs, What's Going On?

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets three times a week. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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