One of the relatively newer sets of exchange-traded funds in the market are known as “smart beta” funds. As opposed to passive indices, where managers simply throw together an index that doesn’t require them to do any actual work, smart beta ETFs are what I refer to is being “pseudo-managed.”
Smart beta ETFs are created by taking a very specific approach to an index, such that it kind of becomes a subset of a particular index. This might be driven by a computer or someone else noticing that certain securities behave in certain ways given certain circumstances. Smart beta ETFs may also derive from some kind of market inefficiency that a computer or fund manager notices.
Smart beta ETFs can be great ideas, or they can be terrible ones. However, if chosen properly, they can add a degree of non-correlation to your overall portfolio. Investing in non-correlated assets is a cornerstone of my investment advisory newsletter, The Liberty Portfolio. Not enough attention is given to non-correlated investments, which are necessary in order to reduce overall volatility in your portfolio. Chances are you don’t have any uncorrelated investments in your portfolio, so taking a look at smart beta ETFs may make sense for you.
Here is just a sample of three types of interesting smart beta ETFs.
Essential Smart Beta ETFs: Wisdometree Emerging Markets High Dividend ETF (DEM)
Expense Ratio: 0.63%, or $63 per $10,000 invested annually
WisdomTree Emerging Markets High Dividend ETF (NYSEARCA:DEM) is a perfect example of using a subset of an index when it comes to smart beta ETFs. WisdomTree takes the MSCI emerging markets index and then whittles it down by taking the top 30% of companies based on annual dividends paid. It then waits them based on the highest dividend yield.
The dividend yield is fairly generous at 3.7%. Even more attractive is the price-to-earnings ratio which is an astonishingly low 10.4. There are 502 stocks in the index, of which the top 10 account for 27% of the asset base. The largest weighted sectors in the fund are financials at 23%, energy at 19% and materials at 13%.
The fund is also very dedicated to its idea of emerging markets. Taiwan, China, Russia, and South Africa combined to form almost 70% of the asset base.
Essential Smart Beta ETFs: Ven Eck Vectors Fallen Angel High Yield Bond ETF (ANGL)
Expense Ratio: 0.35%
Ven Eck Vectors Fallen Angel High Yield Bond ETF (NYSEARCA:ANGL) it is one of the most interesting smart beta ETFs I’ve ever come across. The idea here is the fund purchases high-yield bonds that initially received an investment-grade rating when they were issued.
The managers purchased bonds that they believe will regain their investment grade status at some point. This certainly makes a degree of sense if some of the companies that have issued these bonds are going to see additional liquidity due to the corporate tax cut.
It has a surprisingly low net expense ratio of 0.35%, has a 12-month yield of 5.6%, and has 241 holdings in the fund. The index is rebalanced on a monthly basis. I mentioned that The Liberty Portfolio looks for non-correlated assets, and this is the kind of ETF that I might seriously consider adding to it, because this ETF is only 55% correlated to the S&P 500 index.
Essential Smart Beta ETFs: SPDR S&P Regional Banking ETF (KRE)
Expense Ratio: 0.35%
The SPDR S&P Regional Banking ETF (NYSEARCA:KRE) is an interesting subset of both the banking sector and the financial services sector. There are 120 holdings in this fund and its 1.4% yield outstrips the 0.35% expense ratio of the fund.
What I find interesting about regional banks is that they tend to have a very devoted and loyal base of customers. Regional banks have so much less reputational risk than any of the majors do. You never hear about fake bank accounts or toxic mortgages at the regional banks. These are smaller institutions, serving a very specific and localized client base. Individuals and businesses are far more likely to want to bank with a “family bank” than one of the big majors if they can do so.
It’s a bit too tightly correlated to the financial services sector and therefore to the overall market, but not unacceptable by any means.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].