In a livecast event this Friday, I’m going to be recapping the past year in ETFs and previewing what is likely ahead of us with one of my favorite people in the ETF industry that does not work for VettaFi, Cinthia Murphy. As the director of research for ETF Think Tank, Cinthia is also part of the ETF educational session at the Exchange conference that VettaFi is hosting in February for advisors along with continuing education credits. One of the topics will be smart beta. After being dismissed in recent years, these ETFs regained favor in 2022, and I think they will remain there in 2023.
Let’s review what smart beta represents before talking about how strong a year 2022 was for many such strategies and what’s ahead.
Smart beta is a term few people like and some wished to be dead, but many still understand that it represents a segment of the ETF industry that tracks indexes constructed by something other than market capitalization.
That admittedly covers a lot of ETFs. In many cases, smart beta ETFs are connected to a broader benchmark, but are more narrowly built based on one or more fundamental- or price-based metrics. These included dividends, low volatility, momentum, quality, and value. In 2022, many, but not all, of these smart beta strategies outperformed the S&P 500 Index.
The SPDR S&P High Dividend ETF (SPYD) was down just 1.1% in 2022, significantly outperforming the 18% loss for the S&P 500 Index. The Invesco S&P 500 Pure Value ETF (RPV) declined 1.3% in 2022, barely lagging its cousin and yet still crushing the broader market. Meanwhile, the Invesco S&P 500 Low Volatility ETF (SPLV) and the ProShares S&P 500 Dividend Aristocrats (NOBL) were down 4.9% and 6.5%, respectively.
Even the Invesco S&P 500 Equal Weight ETF (RSP), which owns the same 500-plus stocks found in the traditional benchmark (but in a more diversified manner), declined only 12%. Of course, not all smart beta ETFs performed as well. The Invesco S&P 500 Pure Growth ETF (RPG) and the Invesco S&P 500 High Beta ETF (SPHB) fell 28% and 21%, respectively, last year.
Meanwhile, many multi-factor ETFs that combine some of the aforementioned fundamental and valuation metrics were strong performers in 2022. The ALPS O’Shares U.S. Quality Dividend ETF (OUSA), the Invesco Russell 1000 Dynamic Multifactor ETF (OMFL), the iShares US Equity Factor ETF (LRGF), the SPDR MSCI USA StrategicFactors ETF (QUS), and the Xtrackers Russell US Multifactor ETF (DEUS) were all down 15% or less last year.
In 2022, smart beta ETFs gathered a record $94 billion of net inflows, proving that many investors want something other than replicating the S&P 500 Index.
I’m a big believer that past performance is no guarantee of future results and expect that 2023 will be a different market environment than 2022 with a less aggressive Federal Reserve, diminished inflation, and perhaps a U.S. recession underway.
But some advisors seeking a mutual fund alternative will continue to look at smart beta ETFs. These ETFs use investment approaches based on shifting market developments, but in a systematized, low-cost, more tax-efficient manner. In particular, multi-factor ETFs combine styles to ensure that the investor is not caught leaning the wrong way when the 2022 darlings like value, dividends, or low volatility ultimately fall out of favor. Indeed, the S&P 500 High Beta Index beat the S&P 500 Low Volatility Index by more than 1,700 basis points in the three-year period that ended 2021.
Long live smart beta strategies, as their happy shareholders are inclined to say.
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