The new breed of so-called smart-beta exchange traded funds allows active managers to make small bets based on factor investing and beat traditional benchmarks with customized or enhanced indices.

For example, the PowerShares FTSE RAFI 1000 ETF (NYSEArca: PRF), which selects the largest U.S. equities based on book value, cash flow, sales and dividends, has outperformed 85% of large-cap-value funds over the past five-years, outpaced 83% of the funds over a three-year period and beat 87% of large-cap-value funds year-to-date, reports Jason Kephart for InvestmentNews.

This outperformance in a passively indexed strategy provides a stark contrast to the traditional argument that managed funds with high active shares, or funds with a large percentage of holdings that differ from a benchmark.

According to Yale finance professors in 2006, a high active share with over 70% of assets that differ from the index has the best chance of outperforming the index. PRF, on the other hand, has outperformed with a 35% active share difference to its benchmark Russell 1000 Value Index.

The outperformance, though, may be attributed to the way the PowerShares ETF was constructed. Taking a closer look at PRF, RAFI places emphasizes value stocks and provides smaller companies a larger weight. [An Outperforming ‘Smart-Beta’ ETF with a Value Tilt]

Additionally, the ETF only has a 0.39% expense ratio, compared to the average 1.19% expense ratio of large-cap-value funds, and the ETF cuts down on costs with low turnovers. According to the Center for Retirement Research at Boston College, the average mutual fund loses 0.66% of performance a year due to trading costs. [JPMorgan Eyes ‘Smart-Beta’ Developed Global ETF]

For more information on smart-beta ETFs, visit our indexing category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.