Advisors Are Smart Enough to Go Beyond Fees With Smart Beta

Advisors and end clients are gravitating to the cheaper ETFs, regardless of whether the fund is market cap-weighted or otherwise. Indeed, while the average ETF classified by Morningstar as a strategic beta or smart beta ETF charged an expense ratio of 0.41% on an equal-weighted basis, the average fee fell to 0.19% on an asset-weighted basis, according to Ben Johnson, director of global exchange traded fund research for Morningstar.

Morningstar views strategic beta ETFs as those linked to indexes that make active bets of varying types and degrees of magnitude against the broad market cap-weighted benchmarks that are their starting point. These wagers are embedded in the funds’ index methodologies, which are their active playbooks. But unlike conventional active managers, strategic beta funds cannot make adjustments.

Johnson pointed out that in 2021, U.S.-listed dividend ETFs gathered $42 billion, the second-highest among the subcategories, behind only $60 billion for value ETFs. Demand for dividend ETFs has further continued this year, particularly as the Federal Reserve has raised interest rates and made investing in traditional fixed income securities more challenging.

Indeed, according to VettaFi’s ETF data analytics, there were three U.S. dividend ETFs among the 20 most-trafficked pages on our ETF Database platform through the first five months of 2022. All three of them charge the same 0.06% expense ratio, but they are very different.

The Vanguard Dividend Appreciation ETF (VIG) had the most interest from VettaFi’s audience. VIG owns shares of companies with at least a 10-year record of dividend growth. Information technology (23% of recent assets), healthcare (16%), and financials (15%) were the most represented with top 10 positions in JPMorgan Chase (JPM), UnitedHealth Group (UNH), and Microsoft (MSFT). 

The Schwab US Dividend Equity ETF (SCHD) had the second-highest traffic among dividend ETFs this year, according to VettaFi data. SCHD tracks an index focused on the sustainability, but also the quality of the dividend. Financials (21%), information technology (20%), and consumer staples (14%) were the fund’s largest recent sector weightings, with Coca-Cola (KO), International Business Machines (IBM), and Texas Instruments (TXN) all as part of SCHD’s top 10 positions.

Despite identical fees and some similarities at the sector level, SCHD’s 7% loss year-to-date through June 10 was approximately 750 basis points less than VIG’s.

Meanwhile, the Vanguard High Dividend Yield Index ETF (VYM) is performing even better this year. VYM, which as mentioned earlier charges the same 0.06% fee as SCHD and VIG, was down just 4.7%. 

VYM focuses on a company’s dividend yield, not its dividend record, which is why it recently had 7% in information technology stocks, but 9% in energy and 8% in utilities (VIG had less than 1% and 3%, respectively). VYM’s largest exposure was to financials (20%).

As the fees for smart beta ETFs have come down in recent years, often to levels nearly the same as those of market cap-weighted products, it is even more important for advisors to dig deeper, since what is inside will be the bigger driver of performance. The tools on VettaFi’s platforms can help ensure that advisors are sufficiently educated to have the right conversations with their end clients.

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