The Financial Industry Regulatory Authority issued a warning on smart-beta or alternative index-based exchange traded funds as the recent growth and rising popularity attract many new investors.
Many investors have become acquainted with traditional beta index-based ETFs that passively track large benchmarks, like the S&P 500 or Nasdaq Composite, which weight holdings based on market capitalization – the largest companies have the largest weights.
However, a growing group of smart-beta index ETFs track customized indices that select and weight component stocks based on specific factors. Consequently, these alternative index or smart-beta ETFs come with different risks that ETF investors may not think about.
An ETF may track an ETF, but it does not mean that the index is plain vanilla, writes Chris Dieterich for Barron’s.
“While there are potential advantages, including diversification through exposure to nonmarket-cap weighted indexes, products tracking smart beta indices can also carry investment risks, and returns for these products may be very different from investments that track market-cap-weighted indices,” according to FINRA. “Products that track these indices may be complex or unfamiliar for individual investors. They may also have higher expenses.”