With the market-capitalization beta-indexing exchange traded fund space mostly filled out, money managers are expanding into factors-based or fundamental indexing methodologies to provide active strategies in a passive fund structure.

“Exchange-traded-fund companies are following in the footsteps of financial advisor favorite Dimensional Fund Advisors Ltd. and building new products around academic research to offer investors a new way to beat the market,” reports Jason Kephart for Investment News.

“Factor investors probably started off as Bogle-style buy-and-hold investors, then looked deeper into the research,” Samuel Lee, an analyst at Morningstar, said in the story.

Research has shown that overweighting companies with factors like favorable prices, profitability, size or momentum can generate better overall risk-adjusted returns in an investment portfolio. [ETF Index Changes Show Methodology Matters]

“Passive and factor investing are joined at the hip,” Lee added. “Passive is based on a lot of academic and finance theory that says it’s impossible to beat the market. Factor investing is an offshoot of that.”

BlackRock’s iShares, Charles Schwab Investment Management and Northern Trust’s FlexShares have recently added their own ETFs based on investment factors like value, profitability, size and momentum, according to the article.  [Schwab to Launch Its First Fundamentally Weighted ETFs]

Invesco PowerShares is also a forerunner in the fundamental ETF business. [PowerShares Fundamentally Weighted ETFs Hit $5 Billion]

On the demand side, investors are embracing the new breed of intelligent, smart-beta or fundamental index ETFs as the funds outperform traditional benchmark indices. Almost three of five advisors on the Schwab platform are using fundamentally weighted ETFs, and one in five plan to increase usage. [Alternative Weighted Index ETFs Attract Heavy Inflows: Schwab]

“We’re always trying to find new ways to enhance how we invest for clients. Factors do that,” Mark Carver, investment strategist at iShares, said in the article. “As new ideas are vetted, more people are starting to put them into practice.”

For more information on the ETF indexing methodologies, visit our indexing category.

Max Chen contributed to this article.

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