More people are beginning to pick up enhanced, factor-based, smart-beta index exchange traded funds that provide an alternative to traditional index products. While the these ETFS offer investors more choices, investors need to understand the newer indexing methodology does come with its own considerations.
“There is no free lunch,” Rick Ferri, founder of Portfolio Solutions, said in a CNBC article, pointing to the higher-than-average management fees for the smart-beta ETFs.
U.S.-listed ETFs have have an average 0.61% expense ratio, with the cheapest coming in at 0.04%; however, ETFs that follow an enhanced indexing methodology have an average expense ratio of 0.64%, according to XTF data.
Nevertheless, investors should know that the factor-based index ETFs are still cheaper than actively managed funds that can charge annual fees north of 1%. [WisdomTree: What Is Smart Beta Anyway?]
Factor-based ETFs, which follows an index that weights companies based on factors like book value or dividends, among others, provide active management styles in a passive wrapper. Additionally, the ETFs, like stocks, can be bought or sold on an exchange through normal trading hours. [Getting a Handle on Smart-Beta ETFs]
Investors should also look under the hood of any investment before committing to an ETF. Looking at smart-beta ETFs, the investments may lean toward specific sectors. Additionally, some smart-beta ETFs can overweight mid- and small-cap stocks with a value tilt.
“We’re talking about a motley group of strategies,” Ben Johnson, director of passive funds research at Morningstar, said in the CNBC article. “It’s important that investors understand the diverse number of processes.”
Like any other investment, smart-beta ETFs can underperform in certain markets. Consequently, investors should have an investment strategy in place to navigate the changing conditions. For instance, at ETF Trends, we like to use the 200-day exponential moving average to help us decide when we are in or out of a position. [An ETF Trend-Following Plan for All Seasons]
For more information on smart-beta funds, visit our indexing category.