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Smart Beta Is a Rising Trend in ETF Universe

This article was originally published on ETFTrends.com.

As the ETF universe matures, a number of smart beta or factor based ETFs have hit the market, and the strategies are quickly garnering many investors' attention.

"It is an evolution, and it is an education process that goes along with that," Luke Oliver, Managing Director and Head of Capital Markets for DWS, said at the 2018 Morningstar Investment Conference.

Like any other investment strategy, smart beta ETFs come with their own quirks that investors should fully understand to better utilize the investment products in an efficient manner.

For example, DWS offers a Comprehensive Factor ETF suite, including X-trackers Russell 1000 Comprehensive Factor ETF (DEUS) , X-trackers FTSE Developed ex US Comprehensive Factor ETF (DEEF) , X-trackers Russell 2000 Comprehensive Factor ETF (DESC) and X-trackers FTSE Emerging Comprehensive Factor ETF (DEMG) . The X-trackers multi-factor suite selects components based on a broader five factors, including quality, value, momentum, low volatility and size.

For buy-and-hold investors, multi-factor investments help combine uncorrelated investment styles to smooth out volatility. Since there are multiple uncorrelated factors at play, it helps guarantee that at least one factor will help support the portfolio during times of distress. Moreover, a multi-factor ETF removes the need for investors to babysit a portfolio and switch between factors in an attempt to time market moves.

"These are the five factors that we think are very compelling both pro-cyclical and counter-cyclical. And if we combine those in the right way, we provide a portfolio that is an all-weather portfolio," Oliver added.

The quality factor helps hone in on the quality of a company earnings as a better gauge of future earnings performance. The underlying indices may provide a quantifiable measure of each company’s profitability, efficiency, earnings quality and leverage.

The value factor reflects the idea that cheaper equities are thought to outperform more expensive stocks over the long-term. Consequently, the underlying indices will focus on cash-flow yield, earnings yield and sales-to-price of each company as measures of value.

Momentum may reflect the recent price movements over time as an indicator of future stock price movements. Specifically, the underlying indices review the 11-month cumulative total returns of each stock.

Low volatility suggests that portfolios with less volatility or low beta can provide higher-than-average return with smaller drawdowns. The underling indices will calculate the standard deviation of five years of weekly total local returns for each stock.

Lastly, the size factor reflects the historical long-term effect that show long-term outperformance in small-caps over large-caps. The underlying indices will select companies based on full market capitalization.

For more ETF-related commentary from Tom Lydon and other industry experts, visit our video category.