What's So Special About Smart Beta ETFs?

Many investment innovations have been meet with skepticism, but exchange traded funds (ETFs) that track smart-beta or alternative index-based strategies have quickly caught investors’ attention.

Contributing to the rapid growth, smart beta ETFs have helped investors capitalize on actively managed investment styles at a fraction of the cost.

“Strategic beta, unlike most innovations, demands less from portfolio managers, not more,” writes John Rekenthaler, V.P. of research at Morningstar. “As a result, it charges less. There aren’t many investment principles sounder than the statement that expecting less and paying less yields better results than expecting more and paying more.”

Related: Liquidity For Smart Beta ETFs Improves

Smart- or strategic-beta ETFs passively track an underlying benchmark index. However, the underlying indices are not your run-of-the-mill, cap-weighted benchmarks that copy existing markets. These smart-beta indices cherry pick stocks based on specific factors, which give them a kind of active component. For instance, some of the more popular factors or investment styles in smart beta ETFs we are seeing today include low-volatility, value and dividends.

For example, the Vanguard Dividend Appreciation ETF (NYSEArca: VIG), iShares Select Dividend ETF (NYSEArca: DVY) and Vanguard High Dividend Yield ETF (NYSEArca: VYM) are some popular dividend-oriented ETF strategies. Moreover, investors have been looking at low-vol strategies, like the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) and PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), this year.