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Smart-Beta ETFs Require Some Due Diligence

Smart-beta, or strategic-beta, indexing strategies are an up-and-coming theme in the exchange traded fund space. However, the majority of retail investors don’t know anything about smart-beta, revealing the greater need for education for the quickly evolving industry.

Ben Johnson, Morningstar’s director of passive funds research, points out that there were 374 exchange traded products that track strategic-beta strategies, with about $360 billion in assets, as of June 30, reports Joseph Lisanti for Financial Planning.

However, according to Charles Schwab research, 67% of its clients admit that they do not know anything about smart-beta ETFs. On a recent Russell Investments survey, institutional investors revealed that about one-third of the group already use smart beta strategies.

“We need more clarity, more education,” Rolf Agather, who heads up research at Russell Investments, said.

Looking at smart-beta strategies, the varying ETF offerings share a single common theme: they avoid the capitalization weighting methodology common to traditional indices.

Smart beta portfolios “are breaking the link between price and portfolio weight,” John West, head of client strategies at fundamental index shop Research Affiliates, said in the article.

Luciano Siracusano, chief investment strategist at WisdomTree, explains that the smart-beta ETFs provide targeted exposure “weight by what you want.”

Due to their customized weighting methodologies, advisors and investors will have to take time to more closely examine the underlying holdings and investment strategy behind the smart-beta ETFs. [WisdomTree: Targeting Benchmark Size Exposures with Smart Beta Indexes]

Many WisdomTree ETFs are weighted by the absolute dollar value of a stock’s dividend payout. For example, the WisdomTree LargeCap Dividend Fund (DLN) allocates a greater weight toward companies with a higher dividends. AT&T (NYSE: T) has a larger 2.9% weight in DLN than General Electric (GE) 2.14%, because AT&T issued a $9.5 billion in total annual dividends, compared to General Electric’s $8.8 billion. [How Smart-Beta ETFs Differ Traditional Cap-Weighted Funds]

“Because we weight once a year by dividends,” Siracusano said, “we capture dividend growth.”

Bill Belden, managing director of product development at Guggenheim Investments, argues that the Guggenheim S&P 500 Equal Weight ETF (RSP) , which equally weights S&P 500 index components, provides “better diversification” than the traditional cap-weighted index.

Additionally, potential investors should be aware that many smart-beta strategies overlap, so people shouldn’t go overboard with their ETF selections as they could unknowingly go overweight a specific sector or stock.

For more information on smart-beta ETFs, visit our indexing category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.