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What you need to know about smart beta

As the middle ground between active and passive investing, ‘smart beta’ ETFs are gaining in popularity – here’s why


Date: May 9, 2017

Most people don’t like rules, unless the additional structure has the potential to make them money.

Rules-based investing is the concept behind strategic beta exchange-traded funds (ETFs), also known as “smart beta” ETFs — an investment strategy that’s gaining in popularity among investors.

Instead of using a market-weighted approach, similar to the S&P 500 or S&P/TSX composite index (sometimes known as “simple beta”), smart beta uses more specific factors that have historically outperformed the market, such as value, dividends or low volatility.

What makes them “smart” is the different way of thinking beyond traditional active or passive investing by applying additional screens to the list of securities that might be purchased in a fund.

“Smart beta funds track an index that deviates from a broad market-cap-weighted approach,” says Christopher Davis, a strategist at Morningstar Canada.

“If you were to invest in a value-oriented Canadian or U.S. equity ETF, for example, that’s smart beta because you’re moving away from a market portfolio and you’re [targeting] value stocks.”

More Canadians are choosing smart beta ETFs. The value of Canadian ETFs reached about $123-billion as of March 31st, according to Morningstar. Of those, about $14.6-billion, or just under 12 per cent, are smart beta ETFs.

Best of both worlds

Smart beta ETFs are considered the middle ground on the active-to-passive investing spectrum, says Krista Matheson, head of ETFs and structured products with Manulife Investments.

“It takes a bit from both worlds; the active insights and the passive implementation,” says Ms. Matheson.

Investors often choose them as a way to try to boost returns and minimize risk, relative to a traditional market-capitalization-weighted benchmark. With a market-weighted approach, for example, one heavily-weighted, underperforming stock can drag down results of the entire fund.

And while smart beta ETFs may have slightly higher fees than traditional ETFs, they’re often cheaper than actively managed funds.

Greater transparency

Smart beta ETFs are also considered transparent because investors can easily track the performance and see the holdings in the portfolio at any time, says Ms. Matheson.

“It’s also transparent when it comes to understanding how the fund is going to target specific outcomes,” she notes.

For example, with a rules-based strategy, investors can see and understand what factors the fund is using to screen for various securities, such as value or dividends.

“From there, you should have an idea of what to expect from that portfolio — as well as the costs over time,” says Ms. Matheson.

“It’s a way to get value-added exposure at a low cost.”

Removes emotion

Another advantage with smart beta ETFs is that investment decisions are based on data and not human emotion that can sometimes cloud investing judgment, especially when markets are volatile.

“No smart beta strategy will be emotional,” says Mr. Davis. “You’re investing with a robot or computer program that is going to behave the same way every time.”

Of course, humans are still investing in the funds, he says, “but the actual strategies themselves are very systematic.”

Still, as with any investment, Mr. Davis cautions investors to do their due diligence when selecting smart beta ETFs. Investors should also be patient when seeking results and have a longer-term horizon.

“The greatest strategies in the world don’t work unless investors are willing to stick with them,” he says.

Sponsored by Manulife

Commentary is for general information purposes only and should not be relied on for specific financial or other advice. Opinions expressed are subject to change based on market and other conditions. Commissions, management fees and expenses all may be associated with exchange traded funds (ETFs). Investment objectives, risks, fees, expenses and other important information are contained in the prospectus, please read it before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

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