As the number of strategic- or smart-beta exchange traded funds proliferate, potential investors should understand how the various products work and how the strategies can fit into an investment portfolio.

These smart-, alternative- or strategic-beta ETFs that track specific factors can cover a number of broad themes, including equal weight, low volatility and fundamental strategies, which employ varying screens and weights, as opposed to traditional market-capitalization-weighted methodologies, writes Anthony B. Davidow, vice president for alternative beta and asset allocation strategist at Schwab Center for Financial Research, for InvestmentNews.

“It’s important that investors understand the different sector allocations, market capitalizations and value-growth tilts of these strategies before making any investment decisions, particularly as the strategies gain popularity,” Davidow said.

Investors can think of the new breed of smart-beta ETFs as a compromise between traditional beta-indexing funds and actively managed strategies. These factor-based ETFs passively track an underlying index, but the indices are customized to mirror actively managed investment styles. [What Smart Beta ETFs Bring to the Table]

For instance, smart-beta ETFs can track companies based on financial health like cash flow, dividends, earnings and book value, or other factors like momentum and relative strength.

“Fundamental strategies can potentially generate excess returns: When it comes to the smart beta slice of the portfolio, we have focused on fundamental strategies because of their strong absolute and relative results compared to traditional market-cap indexes and many actively managed funds,” Davidow added.

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