Many of the latest exchange traded funds that are launching are not the basic broad indexers, rather, they are active strategies. This new active ETFs offer anything from high yield to low volatility.
“They’re a bit trickier to understand, charge a lot more, have limited histories, and often have that whiff of faddishness. Experienced hand or not, you’d probably feel more comfortable with a framework for understanding more-complex funds. As a starting point, think of picking a strategy as very much like being an active manager. Indeed, many hedge funds earn their keep by simply rotating among and blending well-known strategies. The market is hard to beat (isn’t that why we like ETFs?), so expect assessing strategies to be hard work,” Samuel Lee wrote in a recent Morningstar article.
First of all, investors should be aware of how a strategy ETF makes money. “If you’re buying a strategy in the hopes of earning market-beating returns, you better have a very good reason to justify your belief,” Lee wrote.
A market-beating strategy, in theory, is often times re-packaged risk, not supported with solid data and evidence and already overcrowded. [Low-Volatility ETFs May Underperform in Bull Market]
Some of the most popular strategies that are applied to ETFs include value, momentum, and the latest low-volatility funds could hold the most water. Over the long term, low-volatility strategies have outperformed high-volatility strategies on a risk-adjusted basis. Remember, low-volatility is in line with a value strategy. [ETF Chart of the Day: Low-Volatility Funds]
Strategy analysis can be an important step in portfolio construction, especially if you want to beat the odds. The next time a strategy looks appealing, decide if this is one that could remain in your portfolio over the next 20 years. Lee says that if you can’t answer yes, the supporting evidence has not convinced you. [ETFs Driving Higher Correlations, Market Risk: Paper]
Tisha Guerrero 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.