ETF 101: An Easy Way to Explain Smart Beta to Clients

Note: This article is courtesy of

By Paul L. Keeton, Vice President at Dorsey, Wright & Associates (A Nasdaq Company)

In case you missed it, along with just about every kid finishing third grade this year, Smart Beta ETFs have now been around for about a decade. Yet despite their relative maturity, many advisors continue to find it challenging to explain Smart Beta to their clients. No matter how logical it may seem to those of us who live and breathe investing, it can sound like a complicated blur of numbers, figures, and magical formulas to an investor who is seeking a higher level of performance but knows little about market dynamics or the technical strategies behind Smart Beta ETFs.

The solution? The next time you sit down to talk about Smart Beta to a client, consider taking this simple approach we’ve used to educate third graders on the topic:

Step #1: Introduce how supply and demand affects price

Tear open a large bag of M&Ms in a third-grade classroom, and you have everyone’s attention. (The same is probably true when you sit down with a client, even though you’re just talking through the idea.) In the classroom, if we divide 125 M&Ms equally among the class so each child has 5 M&Ms, everyone is equally happy. If we ask who wants to trade their M&Ms, no hands go up. But if we introduce new information, the game changes. Tell a class of third graders that blue M&Ms are guaranteed to make them run faster, and suddenly there’s a run on the market. When the kids are asked to trade candy this time, what happens? Suddenly the balance between supply and demand has changed. Everyone wants blue M&Ms and for this reason they now have greater market value than before. What changed that value? In this case, it was the introduction of new information. And, of course, as demand increases, so does price. One blue M&M may now fetch the price of two or three M&Ms of another color.