Tahoe Market Pulse: Taking a look at smart beta funds | SierraSun.com

Tahoe Market Pulse: Taking a look at smart beta funds

I have written that the debate on the merits of passive versus active investing is over. Indeed it is. Investors are choosing passive funds due to their low fees and solid performance.

But most passive index funds are capitalization weighted, which means large-cap stocks have far more influence on performance than smaller ones. That could be good … or not. Some believe there is a better way. That’s where “smart beta” funds come in.

Smart beta funds bridge the gap between passive and active management. Rather than tracking a capitalization weighted index, as passive funds do, or being picked by an individual (or team), as with actively managed funds, smart beta funds use quantitative rules to determine their holdings and weightings. The goal is to improve risk-adjusted returns while retaining the low costs associated with index investing.

Possibly the first smart beta ETF was the Guggenheim G&P 500 Equal Weight (RSP), which holds an equal dollar amount of every S&P 500 stock. It has outperformed the index itself since inception (2003), 11.2 percent versus 10.6 percent.

One of the first ETF families to exclusively offer rule-based funds was WisdomTree. For more than ten years they’ve weighted fund holdings by dividends instead of market capitalization.

More recently, they added the WisdomTree U.S. Quality Dividend Growth ETF (DGRW) that fundamentally weights large-cap companies on dividends, earnings growth expectations, and return on equity. The largest holdings are Johnson & Johnson (JNJ), Apple (AAPL), Microsoft (MSFT), Altria Group (MO), and PepsiCo (PEP).

These are still index ETFs so their costs are low, albeit not as low as passively managed funds. Last year 103 smart beta ETFs were launched compared to only three active ETFs. Still, they remain behind passively managed funds, which saw inflows of $280 billion in 2016.

Here are some smart beta ETFs worth considering: A good holding for nervous investors is PowerShares S&P 500 Low Volatility Portfolio (SPLV). It holds the stocks in the S&P 500 that exhibit the least volatility. Utilities comprise 20 percent of its holdings. The expense ratio is 0.25%.

For those interested in more growth, consider Vanguard Dividend Appreciation ETF (VIG). It holds companies (even ones outside of the S&P 500) that have increased their dividends for at least 10 consecutive years. The expense ratio is only 0.09%.

While I’ve selected domestic ETFs for this article, there are smart beta funds that focus on international stocks, too. While the quantity of new ETFs can be overwhelming, many allow investors to own a diverse portfolio of stocks with attractive characteristics. They’re worth considering.

David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.

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