Even if smart- or strategic-beta exchange traded funds provide interesting investment strategies, investors should still check the costs as some passive strategies may come with higher fees.
Ben Johnson, Director of Passive Manager Research at Morningstar, argues that when looking at strategic-beta ETFs, investors should consider costs and the underlying index.
“I think investors should focus on costs in virtually all contexts, but I think in this context, it’s particularly important because in many cases index providers, ETF providers are using this sort of innovation, this increased complexity as a way to justify relatively higher fees vis-a -vis a traditional broad-based market index exposure,” Johnson said.
For instance, there are over 400 U.S.-listed ETFs that follow an enhanced indexing strategy and come with an average 0.62% expense ratio, according to XTF data. In contrast, traditional beta-index-based ETFs have an average expense ratio of 0.56% and actively managed ETFs have an average 0.83% expense ratio.
The strategic beta, scientific beta, factor-based investing or fundamental indexing ETFs are all based on a rules-based indices that implement a highly regimented investment objective that mirrors actively managed styles. [The Growing Smart-Beta ETF Space]
While smart-beta ETFs are relatively cheap, compared to actively managed funds, some of the smart-beta strategies can charge higher fees, with some near active management prices. For instance, the cheapest alternative index-based ETF tracks a U.S. dividend equity strategy and comes with a 0.07% expense ratio, whereas the cheapest traditional beta-index ETF has a 0.04% expense ratio. Additionally, the most expensive smart-beta index ETF has a 1.66% expense ratio.
Johnson also mentioned that investors should stick providers that are experienced with running index funds since managing these types of alternative indices are more complex than indices with broad market exposure. Moreover, he argues that knowledgeable providers may be more reliable.
“A capable and responsible sponsor is going to emphasize launching investable strategies that have lasting investment merit and likely doing so at a low-cost as opposed to just chasing a fad and emphasizing marketability over a strategy’s actual investment merit,” Johnson added.
For more information on smart-beta ETFs, visit our smart beta 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.