Are Smart Beta ETFs actually smarter?

Ahmed Farooq, CIMA®, CFP

Ahmed Farooq, CIMA®, CFP
Vice President - ETF Business Development at Franklin Templeton Canada

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When it comes to new ETFs entering the Canadian market place, Smart Beta strategies are continuing to offer some buzz to the industry. According to National Bank’s ETF Research desk, $745B has been invested in Smart Beta strategies in the US and $14.6B in Canada, representing 21% in total US assets and 9% for Canada! With so many different types of Smart Beta products, it’s important that investors understand how they work and what outcomes these products are trying to achieve.

Growth of ETFs graph

So what is Smart Beta trying to accomplish? Well its main goal is to provide the investor with an overall better risk-adjusted return. To do this, an investment management team would create a custom index that is designed to outperform the traditional cap-weighted indices that are often used as a benchmark.

This is similar to what an active manager is trying to accomplish. I like to describe Smart Beta as a quasi-active strategy, since there is a human element to get the rules and screens figured out, but once the strategy is implemented, it is essentially then run passively.

So how do I know which Smart Beta strategy to buy? As the number of products and providers offering these types of strategies continue to increase, the search for the right offering can be overwhelming. Due diligence is a must. It is very important to check under the hood and un-wrap the nuts and bolts, so to speak.

As with most types of investment products, I find simplicity is the key. If the methodology is too complicated then you are going to have a harder time understanding it, let alone explaining it to your clients. For the average investor, a smoother ride over the long term could be an appealing option when it comes to Smart Beta strategies. These types of strategies tend to provide a lower overall portfolio beta, which over the short and long term, is an easier ride for investors to stomach.

A multi-factor Smart Beta strategy that pairs factor such as quality, value, momentum, and low volatility  have historically provided a smoother ride with less volatility. Don’t underestimate the value that a smoother ride provides. One of the biggest risks investors face is their own reactionary behaviour and lack of discipline.

Over past few months there have been some notable examples where we have seen this happen. Big companies have seen huge selloffs for a variety of reasons:

Markets are driven by emotions and can result in wild swings, but a smoother ride provided by the right type of Smart Beta strategy can help investors fight their own worst enemies: themselves.

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What Are the Risks?

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.