Every few decades, the finance industry gets disrupted by a hot new investing trend.
In the late-1980s and 1990s, the mutual fund industry boomed.
Soon after, exchange-traded funds started to appear, and, by the early 2000s, were extremely popular.
Investors liked their low trading costs and ability to deliver benchmark returns by tracking an index, a commodity, bonds, or a basket of assets.
ETFs traded like a common stock on an exchange and were therefore easy to buy and sell.
Now, investors appear to be enchanted by smart beta strategies.
Smart beta ETFs are carefully constructed indexes that rank stocks by traits other than their market value, the standard methodology employed by traditional benchmarks, such as the Standard & Poor’s 500.
Instead, these products focus on “factors,” such as growth, value, dividends, volatility or other financial metrics that offer the possibility of market-beating performance and reduced portfolio risk.
Broadly speaking, smart beta assets under management have more than doubled since 2012, and now top $500 billion, according to Morningstar.
If you zero in on just smart beta ETFs, assets under management are now about about $316 billion.
BlackRock — the world’s largest ETF provider — predicts the smart beta funds could blow by the $1 trillion mark by 2020.
What’s behind the explosive growth?
For investors seeking higher, risk-adjusted returns, smart beta strategies may be worth a look.
Such financial products combine elements of passive index-tracking and active fund management to deliver the best of both worlds: transparent construction, diversification, and potentially enhanced returns—all at a relatively low cost.
Some 45% of smart beta funds surveyed by BlackRock last year had expense ratios below 50 basis points.
Academic research by MSCI and other investment firms suggests that “factor investing” may offer improved long-term portfolio returns with possibly less risk.
Smart beta products come in all flavors.
Some smart beta ETFs are pretty straightforward, but others are based on complex methodologies.
So, definitely read the prospectus, check out the provider’s website, and consult an investment professional, if need be, to make sure you’re adequately informed.
Consider, too, that smart beta ETFs are rebalanced on a regular basis to better meet the investing goals set by the portfolio manager. The resulting higher turnover may have associated commissions and tax implications that need to be considered.