Smart beta is one of the newest buzzwords in the investment world. As financial institutions seek out new and different products to sell to investors, they have landed on an interesting theory and wrapped ETFs around it.
It may help to think of these ETFs are being “quasi-managed”. Basically, managers will choose some kind of index that they ostensibly will mirror, but the way they stack their smart beta ETF is going to vary based on different factors.
So, instead of just a cap-weighted mid-cap value ETF, a manager may see some kind of market inefficiency to take advantage of, and instead creates a mid-cap value ETF. Except, this mid-cap value ETF is weighted by stocks trading below a price-to-sales ratio of 1.
Basically, smart-beta ETFs try to reduce risk by taking advantage of these inefficiencies, and in the process outperform the straight-ahead cap weighting of an index. Needless to say, there are countless versions of smart beta ETFs, and I’m just trying to find one for everyone type of investor.
Here are three smart-beta ETFs for different kinds of investors.
Smart Beta ETF for Aggressive Investors: WisdomTree DFE
The market as a whole isn’t doing spectacularly well, but that’s exactly the kind of environement that smart-beta ETFs are supposed to shine in, anyway.
It’s also worth noting that international stocks have not participated in as much of the upside of the domestic market over the past few years. That’s why, for more aggressive investors, I’d have a look at the WisdomTree Europe SmallCap Dividend ETF (DFE).
Obviously, the fund focuses on small-cap European stocks — ones that also pay dividends. Investors can rest assured that the companies are cash-flow positive enough to return capital back to shareholders. However, the smart beta angle here is that it takes the bottom 25% of the market caps of the WisdomTree Europe Dividend Index after the largest 300 companies get tossed out. The remainder are weighted according to annual cash dividend paid.
DFE charges 0.58% in expenses — or $58 annually for every $10,000 invested. The ETF is up 6% YTD.
Smarta Beta ETF for Conservative Investors: PowerShares SPLV
It may sound strange to suggest a fund that is down for the year, but smart beta is about reducing downside without nuking your upside potential.
The S&P 500 is down 1.4% YTD. However, the PowerShares S&P 500 Low Volatility ETF (SPLV) is only down 1%. Over a 3-year period, the S&P is up 58% vs. 50% for the SPLV.
So, when the market is down, the SPLV isn’t down as much, but it also isn’t up as much during the good times. Still, SPLV isn’t lagging all that much, and you are getting a fund with a beta of 0.76 — meaning it is about 76% as volatile as the S&P 500 itself.
And that’s exactly the point! The SPLV takes the 100 stocks from the index that have the lowest realized volatility over the past 12 months. Thus, risk is smoothed out, making SPLV a great smart-beta ETF for conservative investors. Expenses run just 0.25%.
Smart Beta ETF for Income Investors: O’Shares (OUSA)
It’s too early to tell if Kevin “Mr. Wonderful” O’Leary’s five new smart beta ETFs will outperform or not, but given what we know about him as a money and asset manager, it may be worth looking more into these funds. It’s always risky to jump into a new ETF until its performance is proven, but based on O’Leary’s litany of conservative income mutual funds, I think it may be worth a try.
He has several of these funds, but I would stick with the domestic play as represented in the O’Shares FTSE US Quality Dividend ETF (OUSA). The fund only opened in April and is up 2.4% since then, outperforming the S&P 500 (which is flat).
The target index he uses is the FTSE US Quality/Volume/Yield Factor 5% Capped Index, which targets companies that have a higher dividend yield than the underlying index, while pulling out stocks that have high yields due to lower stock prices coming as a result of bad news.
The net expense ratio for OUSA is 0.48%. But there are a variety of factors that go into both this index and O’Leary’s alteration of it, so its best to read the fund literature.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
