In response to the quickly expanding alternative index-based exchange traded funds space, Morningstar has created the industry’s first strategic-beta, or smart-beta, classification system to help investors better understand the inner workings of the funds.
According to a press release, Morningstar’s Strategic Beta Exchange Traded Product Classification System will help identify, compare and analyze strategic beta investment products.
“The need to define, measure, and scrutinize the strategic beta space has increased as investors have flocked to these products and they’ve grown more complex,” Ben Johnson, Morningstar’s director of manager research for passive strategies, said in the press release. “Investors need to undertake the same degree of due diligence when evaluating strategic beta products as they would for active investment managers.” [Use of Smart Beta ETFs on the Rise]
The research provider divides up the space into three sub-categories, including return-oriented strategies that try to improve returns relative to a benchmark, risk-oriented strategies that increase or decrease the level of risk relative to a benchmark, and other strategies that include those excluded by the other two sub-categories. The new breakdown helps investors better understand the variety of options and investment styles available.
Strategic beta, or what many call “smart beta,” refer to a group of indices and investment products that try to enhance returns or diminish risk relative to traditional market-capitalization-weighted benchmarks.
“At Morningstar, we don’t use this term because ‘smart’ implies that these strategies are somehow superior to their traditional counterparts,” according to Morningstar. “We believe the term ‘strategic’ is more appropriate; after all, the indexes underlying these investment products are designed with strategic objectives in mind.”
The strategic beta indexing methodologies capture many of the same factors that active managers employ, such as value, growth, quality and momentum, among others. However, unlike an actively managed fund, strategic beta ETFs passively track an index, so the strategic beta indices are seen as a middle ground between active and passive methodologies. [Advantages of Smart Beta ETFs]
According to Morningstar data, there were 673 strategic beta ETPs with $396 billion in assets under management, accounting for 19% of the overall U.S. ETP industry.
For more information on ETF indices, visit our indexing category.
Max Chen contributed to this article.