Archive | October, 2016

Smart Beta ETFs: Summing it All Up

This is Part 10 in a series about smart beta ETFs. See below for links to other posts in the series. In this final installment, we review what we’ve learned and consider the pitfalls of embracing smart beta strategies.


At last we arrive at the final post in this series on smart beta ETFs. From the comments, tweets and few cancelled subscriptions, I know some readers didn’t make it this far. Even if you stuck it out, you’re probably asking why I’ve devoted so much space to this technical subject. After all, I’ve spent years arguing that investors should keep things simple with traditional index funds and ETFs, and let go of the dream there’s something better out there. Have I changed my tune and embraced a strategy that strives to beat the market by tilting toward value stocks, small caps, momentum, low volatility and high-quality companies?

Let’s be clear: I haven’t changed my position. I still recommend plain old cap-weighted ETFs for DIY investors, and our full-service clients. I still use them in my own portfolio.

So why devote so much space to smart beta?

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Is Your Smart Beta Strategy Doing Its Job?

This is Part 9 in a series about smart beta ETFs. See below for links to other posts in the series. In this installment, we look at how you can tell whether smart beta indexes will really perform as expected.


As we’ve worked through each of the factors targeted by smart beta ETFs—value, size, momentum, low volatility and quality—we’ve been careful to point out that no one really knows whether these premiums will persist in the future, especially once they’re on the radar of millions of investors.

However, we can look backward to see whether smart beta indexes have actually behaved as you would expect. Say you’re considering an ETF that targets value and small-cap stocks. If the index did well when value and small stocks outperformed, and did poorly when they lagged, that’s reassuring. But if you find the index’s performance had no correlation with value and size—or if it delivered outsized returns during periods when these stocks were dogs—that’s a red flag. It would be difficult to put a lot of faith in that ETF.

Think of a gardener who buys a system of rain barrels to capture the precipitation that falls on her roof.

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Exploring Multi-Factor Models

This is Part 8 in a series about smart beta ETFs. See below for links to other posts in the series. So far we’ve looked at ETFs that target specific factors. In this installment, we look at funds that offer exposure to more than one.


Over the last few weeks I’ve looked at the five factors most commonly associated with smart beta ETFs: value, size, momentum, low volatility and quality. The specific funds I’ve mentioned so far are designed to zero in on one of those factors. But what if you wanted to target more than one? Should you just use several funds, or are their ETFs that use “multi-factor” strategies?

Let’s first consider the reason for building a portfolio with exposure to more than one factor: better diversification. As we’ve seen, each factor is virtually guaranteed to see periods of underperformance, even if they deliver higher returns over the long haul. This can lead to tracking error regret, which is the frustration investors feel when they lag the broad market. Unless you believe strongly in your smart beta strategy,

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