There are many different types of smart-, strategic- or enhanced-beta index-based exchange traded fund funds. Some combine a number of factors to potentially enhance returns and diminish risk, providing investors with suitable core portfolio exposure.
For instance, the relatively new Deutsche X-trackers Russell 1000 Enhanced Beta ETF (NYSEArca: DEUS) and Deutsche X-trackers FTSE Developed ex US Enhanced Beta ETF (NYSEArca: DEEF) both track enhanced beta FTSE Russell indices that target quality, momentum, value, size and volatility – five key factors many financial institutions have looked at to help gain an edge over traditional beta indexing methodologies.
“Emphasizing these characteristics, or factors, can potentially produce a significant contribution to outperforming traditional market cap-weighted indices,” Arne Noack, Director of Exchange Traded Product Development at Deutsche Asset & Wealth Management, said.
For instance, over the past 15 years, the developed ex-U.S. combined factor index has outperformed the benchmark FTSE Developed ex-U.S. Index, according to backtested FTSE Russell data.
When considering value investments, investors may consider some intrinsic measure of a company, like earnings, book value of equity, or sales, and the price that the market puts on the measures, according to Deutsche Asset Wealth & Management. The lower the price, the better the perceived value makes the investment comparatively cheap to others. FTSE Russell uses the simple average of cash-flow-, earnings- and sales-to-price in measuring value.
The size factor considers market capitalization as an indicator of performance, with small-cap stocks historically outperforming large-caps. Smaller companies are in some respects perceived as being marginalized – small-caps are less liquid, have less coverage and are not part of well known indices. However, these same characteristics may make small-caps popular plays for future growth.
The momentum gauge singles out recent price movements-over-time as a potential indicator of future performance. Essentially, momentum traders believe that high-flying stocks will soar even higher. Behavioral economists may explain that the best performers are the ones that typically garner the most attention, which would help drive additional investment demand for the popular plays.