As alternatively weighted, intelligently indexed or smart beta exchange traded funds have grown in prominence, so has the unfortunate notion that users of exchange traded funds must choose sides: Market capitalization weighting or smart beta.
“There seem to be two camps, one singing its praises and highlighting growing investor demand. The other side points out that not all of these strategies are the same and thus they should not be grouped together,” said S&P Capital IQ in a new research note.
Advisors and investors need not pick sides because it is possible and potentially rewarding to combine cap-weighted and smart beta strategies within the same portfolios. Some ETF strategists are already doing just that. [Cap Weighted, Smart Beta ETFs Can Work Together]
The growth alternatively weighted ETFs has been stunning. In the 12 months ending March 2014, smart ETFs hauled in a quarter of ETF inflows while representing just 10% of the available funds on the market, said S&P Capital, citing PowerShares.
PowerShares is the fourth-largest U.S. ETF sponsor and one of the largest issuers of smart beta funds. One of the firm’s largest smart offerings is the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF).
PRF, which turns nine years old later this year, has $3.5 billion in assets under management. Rated overweight by S&P Capital IQ, PRF holds more than 1,000 stocks, leading to comparisons against traditional broad market ETFs and the assertion that small-caps drive PRF’s returns. In reality, less than 5% of PRF’s weight is allocated to small-caps, according to PowerShares data.
Since the March 2009 market bottom, PRF has returned almost 297% compared to an average gain of 227.5% for the S&P 500 and the Vanguard Total Stock Market ETF (NYSEArca: VTI). PRF has only been modestly more volatile than VTI and the S&P 500 over that time. [How Smart Beta ETFs Compare to Traditional Benchmarks]