The $1.6 trillion ETF industry is presently dominated by plain vanilla market capitalization weighted products that simply replicate the market or a particular segment of the market. With their low-cost and transparent methodologies, they are very popular with investors. (Read: High Quality ETFs for long-term outperformance)
However many investors now demand more than just market benchmark returns from their ETF investments and look for products that have the potential to beat the market. Some of these products sponsors call them “Smart Beta” products though terms like “Advanced or Alternative Beta” appear to be more acceptable in the industry.
With the demand for these products surging, many sponsors are now coming with new products with these "Advanced” strategies. Per IndexUniverse, these ETFs have attracted inflows of $46 billion so far this year, resulting in a 20% increase in AUM. With total assets of $228 billion, this segment of the market now accounts for about 14% of all US listed ETF assets. (Read: 3 Niche ETFs Crushing the Market)
What is Smart Beta?
These indexes attempt to select stocks that have better chances of risk-return performance, based on certain fundamental characteristics or a combination of such characteristics. (Read: Beat the market with Smart Beta ETFs)
While this space offers a number of choices to investors, including simplest equal-weighting, fundamental weighting and volatility/momentum based weighting methodologies, not all these strategies have been able to deliver superior results.
Dynamic ETFs in Focus
The goal of "Dynamic" Indexes is to provide superior risk-adjusted returns by choosing stocks based on investment merit. The Intellidex universe includes 2,000 U.S. stocks, which are evaluated using a proprietary investment methodology based on 25 factors that measure company fundamentals, stock valuation, timeliness and risk.
There is a family of ETFs linked to the Intellidex index strategy across a wide range of categories, including board-market, sectors and industries. Each of these products tracks a corresponding Intellidex Index, delivering access to enhanced index investing. While each incorporates quantitative screening process, different categories have different changes and tweaks to the overall process, according to the sponsor Invesco PowerShares.
Like other "Advanced Beta" ETFs, all Dynamic Index ETFs have not been successful. Below we have highlighted three options—one each from broad-market, sector and industry specific space--that have delivered better results than their market-cap weighted counterparts consistently.
PowerShares Dynamic Market Portfolio (PWC)
Launched in May 2003, this ETF is one of the more popular funds in this category, with over $155 million in AUM. The product seeks to track the Dynamic Market Intellidex Index. It charges an expense ratio of 60 basis points.
It currently holds100 stocks with a focus on large caps. Hess Corp, Valoero Energy, Archer-Daniels and Costco are the top holdings. However the fund is well-diversified with the top holding accounting for just 3.9% of the asset base.
The product has a tilt towards technology (18%), while consumer discretionary, energy, financials, health care, and industrials also receive double-digit allocations.
The ETF has returned 39% in the last one year compared with 27% for the S&P 500 ETF.
PowerShares Dynamic Industrials Sector Portfolio (PRN)
Launched in October 2006, PRN seeks to match the price and yield of the Dynamic Industrials Sector Intellidex Index.
The product has an asset base of $91million, invested in of 60 industrial companies. It provides exposure to almost all segments of the industrial sector with double-digit allocation to Aerospace & Defense, Machinery, Airlines and Commercial Services & Supplies.
Among individual holdings, Delta Airlines, Southwest Airlines and Boeing occupy the top three spots.
PRN is a bit expensive with an expense ratio of 65 basis points annually but it has been beating the most popular industrial ETF. It has returned 51% in the last one year compared with 36% for the Industrial SPDR ETF.
PRN is a Zacks Rank # 2 (Buy) ETF.
PowerShares Dynamic Leisure & Entertainment ETF (PEJ)
Launched in June 2005, PEJ the tracks Dynamic Leisure and Entertainment Intellidex Index.
The index is comprised of 30 US leisure and entertainment companies selected on the basis of a variety of investment merit criteria.
Top holdings include Chipotle, Time Warner, Liberty Media, Priceline and Starbucks. Restaurants (43%), Broadcasting (15%), and Movies & Entertainment (13%) are among the top industries.
The fund charges slightly higher fees of 63 basis points per year but it has been outperforming its peers. It has returned 50% in the last one year compared with 39% for the Consumer Discretionary SPDR fund.
PEJ is a Zacks rank #1 (Strong Buy) ETF.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>
Read the analyst report on PWC
Read the analyst report on PRN
Read the analyst report on PEJ
Zacks Investment Research
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report