Your Complete Guide to Index Investing with Dan Bortolotti

Smart Beta ETFs: Summing it All Up

2018-05-29T21:36:19+00:00October 21st, 2016|Categories: Smart beta|Tags: |48 Comments
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? Because it’s the single biggest trend in the ETF world, and it’s not going away any time soon. All of the big fund providers—BMO, iShares, even Vanguard—have joined the party, and the smaller ones such as First Asset specialize in these strategies to set themselves apart from the giants. If you’re going to use a smart beta strategy successfully, you should go into it with your eyes open. And if you’re a traditional index investor—as I hope you are—a thorough understanding of smart beta is the best way to avoid being seduced by its promises.

Before you leap

The previous posts in this series included a lot of information but there were a few recurring themes. Let’s review these important ideas before you fill your portfolio with the latest smart beta ETFs.

The premiums may not last. It’s not fair to dismiss an investing strategy with a lazy wave of the hand, muttering that “what worked in the past might not work in the future.” Some of the factors identified by academics—notably value—have been battle-tested and may well persist, either because they are rewards for assuming higher risk, or because investors have behavioural biases that are unlikely to go away. But others have shorter histories, smaller samples, vague definitions and less compelling explanations. What’s more, as these strategies become more widely known and pursued it seems likely that the premiums will shrink.

Factors are difficult to capture. There are many ways to build an index that targets value, or low volatility, or high quality, and the methodology used by your ETF may have little in common with the ones discussed in the academic research. In other words, even if the factor is real, your ETF may not be capturing it. If you have the time, skill, data and inclination to run regressions on these indexes you may be able to tease out some useful information. But unless you have a master’s degree in finance, it’s awfully difficult to compare smart beta strategies and choose the most sensible one. Many investors will be tempted to choose the one with the best recent performance, and we all know how that usually turns out.

Outperformance will be reduced by fees, transactions costs and taxes. Cap-weighted indexes aren’t perfect, but you should never underestimate the benefit of their rock-bottom costs and reliable tax-efficiency. Many smart beta ETFs carry fees 50 or more basis points higher than traditional index ETFs, and because they’re rebalanced semi-annually, quarterly, or even monthly, they’re likely to incur higher trading costs and distribute more capital gains. These don’t show up in an index’s backtested results, but ETF investors in the real world don’t have the luxury of ignoring costs and taxes.

Investors are human. There have been many periods of five and even 10 years when stocks underperformed bonds, but most of us remain confident equities will deliver over the long term. I’m not sure investors will have the same conviction when—and it’s definitely when, not if— factors like value, size or momentum lag the market over long periods. Investors routinely lose patience when their strategy underperforms for a year or two. Then they jump to another strategy that has enjoyed some recent success, probably just before the music stops.

All investors are prone to bad behaviour, including Couch Potatoes. But I think indexers have a different mindset than those who are attracted to smart beta or active strategies. Index investors are disappointed by low returns, but they don’t usually lose faith when markets are weak, because traditional ETFs typically behave exactly as expected. But imagine an investor who buys a low volatility ETF only to watch it not only trail the market for two years, but also underperform a different low volatility ETF from another fund provider. Would she have the same long-term confidence in her strategy?

So, no, I haven’t abandoned the Couch Potato: on the contrary, the more deeply I look into smart beta and other alternative strategies, the more convinced I become that simple is still the best solution. If you skipped this series because you found it boring or irrelevant, that’s fine: there’s nothing wrong with staying within your comfort zone. If you slogged through all 10 posts, I hope you came away with a nuanced understanding of these strategies, which will become more widespread in the coming years.

Either way, I’ll leave the last word to Benjamin Graham, who wasn’t talking about smart beta, but could have been: “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”

Other posts in this series:

Smart Beta ETFs: Your Complete Guide

A Brief History of Smart Beta

Understanding the Value Factor

Understanding the Size Factor

Understanding the Momentum Factor

Understanding the Low Volatility Factor

Understanding the Quality Factor

Exploring Multi-Factor Models

Is Your Smart Beta Strategy Doing Its Job?



  1. Maxim October 21, 2016 at 12:17 pm

    Great conclusion to a very informative series. Many thanks!

  2. Mordko October 21, 2016 at 12:20 pm

    Nice summary. The one and only smart beta that I use for half of my US allocation is VBR. It has low MER and doesn’t do a lot of buying and selling.

    If this makes me an active investor, so be it.

  3. daniel October 21, 2016 at 12:25 pm

    Hi Dan, I read all your post in this series, and I have to say I deeply appreciate how much effort you put into this. Before you started this series I had a lot of questions and uncertainty about different Smart Beta strategies. You’ve really done an excellent job at addressing all the concerns I’ve had with Smart Beta. This is truly a great contribution to the public discussion of the topic. I for one am sticking to conventional indexes. Keep up the great work, you’re really helping people!

  4. Canadian Couch Potato October 21, 2016 at 12:29 pm

    Thanks for the feedback. I know this topic wasn’t up everyone’s alley, but I am happy to hear it was helpful to those interested in learning more about smart beta.

  5. Mike October 21, 2016 at 12:45 pm

    Excellent series. While I’m a fan of the couch potato portfolio I do believe that a few carefully selected smart beta Etfs could be used to reduce volatility of a purely index based portfolio. In particular, a selection of high dividend Etfs for US and global markets provided the stocks contained within meet tests of; a.) Regular uninterrupted dividends of at least 10 years and b.) increasing dividends over time.

    Do you concur?

  6. Raman October 21, 2016 at 1:29 pm

    Thanks for the great series, Dan. I appreciate the time and effort you spent — even if the conclusions were that most of us should change almost nothing.

    In fact, this whole series reminds me of one of those awful star trek episodes in which the main characters wake up at the end, and realize all the events of the past hour were simply a dream and to be forgotten by the next week ;)

  7. Ross October 21, 2016 at 1:51 pm

    Thank you Dan. Very informative and thought provoking research. Irrespective of the topic then there is often considerable value in targeted devil’s adovcate reflections, perhaps a quite peek to see if the grass is really greener on the other side of the fence. As ever, it seems better to buy financial products rather than be sold them. Keep up the great work.

  8. George October 21, 2016 at 1:51 pm

    Hi Dan,

    Great Articles. I thought it might be a great idea to add your July 15/2013 Articles “Does Smart Beta really Beat Cap Weighting” and Aug 14/2015 “Is it Better with Beta” as a prelude for your list of “Smart Beta ETF’s: Your Complete Guide.” They were very insightful at the time.

  9. David October 21, 2016 at 1:55 pm

    Dan, many thanks for that series. Rather than a passive or index investor, I consider myself an evidence-based investor, who has consistently concluded that the CCP strategy is the best for me.

    Accordingly, I’m anxious to read anything that purports to be a superior investment philosophy or strategy. Your series neatly summarizes this “smart” beta approach, which simply confirms the CCP approach for me. No approach is perfect, so I’ll never close my mind to the possibility of a better strategy, but I have yet to find it.

  10. Paul G. October 21, 2016 at 2:31 pm

    Thanks for all the hard work that must have gone into these. This series reminds me why I like the indexing approach: it’s something I can stick to. And if I don’t follow the markets closely for a while, that’s ok, too.

    If you’re looking for ideas for future posts, I know you prefer presenting the passive approach independantly of products, but breaking down various products as they come out is always interesting. I’d also love to know about how dividends are calculated for ETFs with inflows and outfolws throughout the year.

  11. James Allen October 21, 2016 at 3:36 pm

    Great job Dan. This was very informative and timely. Thank you

  12. Tristan October 21, 2016 at 4:49 pm

    Dan, thanks for a great series. While I couldn’t agree more that simplicity beats complexity hands down, and DIY’s should therefore stick with cap weighted broad market products, for those wanting to tilt their portfolio to value, I’m assuming they ought to do it with cap weighted value or small value ETFs, largely because of their lower cost and less turnover, compared to fundamentally weighted index ETFs?

  13. Régent Lapointe October 21, 2016 at 8:01 pm

    Great series. Thanks a lot for all the good work. I was curious about all these new ETFs. Now I know more about the potential pitfalls. Thank you

  14. sleepydoc October 22, 2016 at 1:23 am

    While I am no longer surprised at the attention to detail and dedication you put into your work to teach the masses, I am always truly grateful. Each time I point another colleague or friend to your site, I am reminded of how much further ahead I am simply because I stumbled upon the treasure of easy to understand information you provide. Are you eligible for any of the categories in the Plutus Awards?

  15. Lake Superior John October 22, 2016 at 12:54 pm

    As always Dan another brilliant post in a series of thought provoking and difficult topics for the average Joe like me to grasp.
    Your fellow readers and replies to this post is a cross section of investors who are varied, diversified, intelligent, and by all accounts patient. For you and them, myself included, to arrive at the conclusion the CCP way is more than likely ” the way to go ” is hard to tear apart. Having read books by Bogle, Malkiel, and the like reinforces index investing ! Difficult to argue against it.
    Then again casinos are filled with hopefuls and wishers. I believe most of us rarely if ever go there.
    Keep up the great work.

  16. Jas October 22, 2016 at 3:41 pm

    Excellent and super informative series. Thanks!

    It seems much easier for a DIY investor to increase the potential long-term return of a portfolio by increasing the equity/obligation ratio of the portfolio, as long as you can tolerate the higher volatility. For this reasons, it seems that tilting a portfolio (with DFA funds or smart beta ETFs) could make more sense for a 100% equity portfolio than for a balanced portfolio? Do you agree?

  17. John H October 22, 2016 at 4:13 pm

    Thank you! This series has been a superb dose of medicine for treating the very early stages of a suspected case of “smart beta ETF FOMO” before it had a chance to spread and infect my CCP portfolio. I can now go back to leaving everything in broad index funds set for “hands-off autopilot ignore” except for scheduled rebalancings… KNOWING that I am not missing the boat by doing so.

  18. Charlie Fox October 22, 2016 at 5:00 pm

    I remember you mentioned (when BMO low vol first came out) that low vol muted the downs and hence also the ups. How come there was no mention of that this time?

  19. LesExpertsLuxembourg October 22, 2016 at 5:20 pm

    Thank you for these articles !

    Check this, I think it can interest anyone :

  20. Jon October 23, 2016 at 2:24 am

    I loved this recent series. Thanks for explaining things in a clear and concise manner!

  21. Nick de Peyster October 23, 2016 at 5:50 pm

    As someone who has built factor portfolios for many years, I believe the single biggest obstacle for exploiting factor (‘smart beta’) anomalies is investor patience. When expressed in a real portfolio (not a backtest) all of these strategies have period bouts of underperformance that outlast the patience of a majority of the investors. In my opinion, these periods of underperformance are what allow smart beta to have a chance to outperform – otherwise, the strategies would become too crowded and never work.

    Nick de Peyster

  22. Jeff October 23, 2016 at 7:08 pm

    Dan, how would you feel about the BMO Discount Bonds (ZDB) that you recommended for tax efficiency outside tax sheltered accounts instead of VAB?

    Can we draw a parralel with smart beta equity ETFs with the potential of losing global diversification or it’s a complete other matter?


  23. Canadian Couch Potato October 24, 2016 at 7:48 am

    @Jeff: ZDB has nothing to do with smart beta: it simply holds bonds that trade at a discount or close to par in order to be more tax-efficient. There is no attempt to outperform the broad market on a pre-tax basis. Nor do you give up any global diversification compared with more traditional bond funds, since most bond ETFs hold Canadian bonds only.

  24. Canadian Couch Potato October 24, 2016 at 8:06 am

    @Tristan: Good question. I think it’s fair to say that if you want to add a value or small-cap tilt it makes sense to do it as cheaply and transparently as possible. Vanguard and iShares have cap-weighted value and small-cap ETFs that are almost as cheap as their total-market ETFs and are likely to have less turnover and more predictable results.

  25. Tim October 24, 2016 at 11:22 am

    Thanks very much for this informative series, Dan. I was kind of expecting you would conclude with no change to the recommendation to use market cap-weighted funds. But you clearly researched and provided the evidence for this conclusion, which makes it all the more convincing.

  26. Craig October 25, 2016 at 11:37 pm

    I found the posts very informative; I have to admit sometimes the deep value tilt espoused by people like Norm Rothery is tempting and the other factors seem useful, but I am glad your conclusion is, effectively, that vanilla total-market ETFs are most likely to be the best option for the majority of people. The simplicity remains the most appealing to me.

  27. Gerry P October 26, 2016 at 12:06 am

    Thanks for an excellent, well-researched and thoughtful series, Dan. I’m wondering f you would classify fundamentally-weighted indexes such as CRQ as smart beta? If so, would they likely behave more like a value weighted ETF or a “quality” ETF? And how would you classify a dividend or dividend growth ETF, in terms of smart beta?

  28. Shaun October 26, 2016 at 1:49 pm

    @ Gerry
    Not sure why anyone would be concerned about trying to classify specific rules into categories. Dan has shown how there is not a firm and universally agreed to definition of any of the smart beta categories which is why it is difficult to choose the best one. Having said that CRQ is intended to track the Canadian RAFI index, which is supposed to be a form of a value index. But they use different rules to select the stocks than other value funds. I have looked at the holding of many of these smart beta funds from different suppliers and there is often very little in common of the holdings and even sectors even though they are supposedly supposed to be tilting to the same general factor.

    With regards to the dividend question, high divided indices are often somewhat similar to value indices, and I believe Dan has posted before how they are “closet value funds”. But again the specific rules each supplier uses and the resulting holdings and performance can vary greatly.

  29. Shaun October 26, 2016 at 2:35 pm

    @ CPP
    Thank you for this informative series. I am surprised by your opening comments on this post of the negative feedback you have received from some readers. Savvy investors know that it is important to continuously question what they think they know and be open to hearing the arguments for alternative strategies. You should be able to investigate an alternative strategy with an open mind. If you do your homework and come to the same conclusion that your existing strategy is best, then you will be more firm in your belief of what you are doing, and more resilient when your willpower is tested. If you are afraid to hear details of alternative strategies because they may actually turn out to better than your existing strategy, then it shows weakness in your beliefs in what you are doing and puts in question if you will be able to stick with it when times get tough.

    I would like to add a bit of a comment on the costs. Because of the more active nature of any smart beta strategy relative to the vanilla index, there are additional trading expenses that go beyond the MER. I know you said that but I think a simple way for people to process this is that smart beta funds will always have more hidden costs or drag than cap weighted indexes even after accounting for the MER. It is generally accepted that the reason many of these tilts including value and momentum in particular have outperformed is because they have more inherent risk of size of drawdown as well as volatility. When you buy these ETFs you are guaranteed to take on that additional risk but are also guaranteed to have to pay more the get it, eating up much of or all of the potential benefit. In other words the risk adjusted returns you get in reality are pretty poor. Likely a more efficient way to take on more risk and potential reward in your portfolio would be to slightly increase your equity allocation but stick with the vanilla indices.

    Having said that I still believe that non-Canadian low volatility funds are a great fit for Canadian investors. I think all your points are valid about the costs, difficulty picking the best fund, possibility of regretting the fund you choose etc. However, I believe that the lower correlation between low volatility funds and the cap weighted Canadian indices is well worth it. As stated previously the low volatility funds all underweight material and natural resource stocks which are significantly overweight in Canada. It is common sense that this would have a lower correlation to the TSX due to the underweight. This lower correlation exists in all the international low volatility funds I could find despite all having different rules and holdings. This sector allocation for low volatility funds has been relatively stable compared to other smart beta strategies.

    Many other authors and bloggers, particularly in the US, are proponents of including a small percentage of gold in a portfolio to improve portfolio risk adjusted returns. They acknowledge that gold on it’s own it a terrible investment with almost no expected appreciation beyond inflation. But, because it has such a low correlation with equities, it can actual improve the performance of the total portfolio.

    So to me the minimum volatility funds don’t have to outperform as they have done in their back tests and in reality to date net of fees. If they continue to do so in the future I see that as a bonus. The research I have done continues to show me that the lower correlation of these funds relative to the TSX is well worth the additional expense when viewed as a part of my total portfolio.

  30. Canadian Couch Potato October 26, 2016 at 2:57 pm

    @Shaun: Thanks for your comments. I don’t have an issue with using low-vol funds as a core holding if you understand the trade-offs, and it seems pretty clear that you do. It would be interesting to see some data comparing the volatility of a traditional Couch Potato equity portfolio (with one-third allocated to Canada, the US and international broad-market index funds) with one that used a traditional Canadian index combined with US and international low-vol indexes.

    @Gerry P: as Shaun points out, the fundamental indexes are a type of value index: I mentioned them in the blog about the value factor. Research Affiliates (creators of fundamental indexing) seem to have an uneasy relationship with the term “smart beta”:

  31. Prasanna October 26, 2016 at 8:05 pm

    thank you Dan for this exhaustive effort which has been very helpful to me…I had a fairly large investment in the ETF “CES.B”…..classic smart beta at the beginning of this series…holding it for just over 2 years….At the end of this series, I have sold it and have purchased XUU instead….having been convinced about the efficiency of market based investments in the long run….to a great extent based on ultra low cost…
    Maple, ON

  32. Shaun October 27, 2016 at 1:42 pm

    @ CCP
    The data is interesting indeed. I found the following website to have a lot of tools that make such comparisons easy to do.

    I was comparing the following 2 portfolios:

    Portfolio 1: 25%. 25%, 50%
    Portfolio 2: 25%. 25%, 50%

    As far as I know XMW is the longest running low vol etf in Canada but still only available since 2013 so the data is limited.

    The backdated data for the underlying min vol index for XMW is available here:

  33. Joon October 29, 2016 at 12:07 pm

    Not about Smart Beta, but just a general q:

    I’d like to change out my VXC (54% US, 46% rest-of-world-ex-Canada) to separate funds, one in US stocks, one in rest-of-world-ex-Canada stocks.

    What would be a close match in Vanguard? VUN for the US aspect? And ?? for the Global?

  34. shaun October 29, 2016 at 5:14 pm

    VIU is what you are after.

  35. Joon October 29, 2016 at 6:36 pm

    Thank you very much, Shaun! :)

  36. Canadian Couch Potato October 29, 2016 at 9:44 pm

    @Joon and Shaun: Actually VIU holds only international developed markets. To replicate VXC more closely you would need to add a third fund for emerging markets. If you want to avoid using VXC, I would suggest VUN (or XUU) plus XEF and XEC.

  37. Garth October 31, 2016 at 7:53 pm

    Hi Dan. Thanks for doing this series. Very informative, but I am confused by one issue. It wasn’t that long ago that PWL Capital was promoting DFA funds, which are of course all about smart beta. Have you and your firm now taken a different tack? Curious minds…

  38. shaun October 31, 2016 at 10:22 pm

    @ joon and ccp
    Sincere apologies joon. Thx for the correction Dan.

  39. Canadian Couch Potato November 1, 2016 at 8:09 am

    @Garth: Most of the advisors at PWL continue to use DFA funds, and many of our clients hold them, too. As we saw in the Part 9 of this series, they do a very good job of capturing small and value if that’s what you’re after. But in the last couple of years we have moved away from them in favour of plain vanilla ETFs. The marketplace has evolved over the years and there are now cheaper, more tax-efficient ETFs than were available just a few years ago, and some places were DFA once offered an advantage are disappearing. The cost difference between ETFs and DFA funds has also become wider than it used to be. And we have certainly seen all of the behavioural issues I’ve discussed in this series: i.e. investors frustrated by a year or two of tracking error.

  40. Nathan November 3, 2016 at 3:47 am

    Hey Dan,

    Unrelated to this post – I’m curious whether you’ve considered, or would consider, replacing the Tangerine option in the model portfolios with WealthSimple. Given their fees (0.35-0.5% + ETF MER, compared to Tangerine 1.07%), and the increased level of flexibility and service, they seem clearly superior.

    As you may recall, I prefer to manage my own ETFs, but I regularly have people ask me what they should do, hence my interest. (Especially since, if you updated the model portfolio or changed my mind, I could just direct people to that page. :) )

  41. Canadian Couch Potato November 3, 2016 at 9:23 am

    @Nathan: I have no major problem with the robo-advisor model, and I think it can be a good alternative to Tangerine. A few issues come up, however. For one, there are so many to choose from that I can’t confidently embrace one over all the others. Nor am I particularly fond of some the ETF portfolios they use: some have exotic asset classes that I would prefer to drop. But if people are looking for a way to get started with ETFs, I wouldn’t hesitate to direct them to one of these options.

  42. Nathan November 3, 2016 at 4:34 pm

    @CCP thanks. Is there a shortlist of Canadian robo-advisor options you’d consider? WS is the only one I’ve heard much about so far.

  43. Canadian Couch Potato November 4, 2016 at 7:57 am

    @Nathan: Nest Wealth also seems to use relatively straightforward portfolios, and they charge a monthly fee rather than a percentage, which is an interesting model. I worry that some or all of the others are likely to go out of business or get acquired by own of the larger players, which would could a bit of disruption for their clients.

  44. Nathan November 4, 2016 at 4:23 pm

    I hadn’t heard of Nest Wealth, but they look like a great option. Found this comparison of several of the options out there, and I’d say they match the couch potato philosophy most closely (with WealthSimple a close second):

  45. Matt November 6, 2016 at 4:08 pm

    Hi Dan,

    In relation to your comment @Shaun and @Joon above. If I want an ETF for developed markets ex north america, are you suggesting XEF over VIU? Thanks,

  46. Canadian Couch Potato November 7, 2016 at 8:34 am

    @Matt: Either one is fine. However, you should use the same fund provider (whether Vanguard, iShares or BMO) for both developed and emerging markets, as the indexes may have overlap if you mix and match.

  47. Garth November 11, 2016 at 12:29 pm

    An excellent podcast with Meb Faber interviewing Larry Swedroe about factor investing.

  48. Top Canadian ETF Providers | ETF Investing January 23, 2017 at 4:50 pm

    […] iShares‘ biggest selling point is probably the lower bid-ask spreads due to higher assets under management in many of its ETFs.  Otherwise, there really isn’t much here that you couldn’t get with Horizons or BMO.  Their international ETFs hold US ETFs (ETF of ETFs structure), which creates an extra layer of fees and withholding taxes (see this blog post).  iShares has a number of smart beta ETFs, but I am not a fan for many of the reasons cited in this blog post. […]

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