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ETF Specialist

Getting Smart About So-Called Smart Beta

Impressive marketing claims and back-tests are no substitute for economic intuition.

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Who wants to be average? While many investors recognize the importance of low costs, it can be unsatisfying to settle for the performance of the broad market, particularly in a low-return environment. That makes it relatively easy for fund sponsors to market strategy exchange-traded funds. These passive funds seek to improve upon traditional broad market-cap-weighted index funds, while retaining benefits, such as low costs, tax efficiency, and transparency. Some of these funds try to enhance returns, while others target different outcomes that investors care about, like low volatility or dividend income. But some may not be able to deliver on their promises. With the recent proliferation of strategy ETFs, it may seem daunting to distinguish between funds that have a good chance of doing what they say they will and those that just have a good marketing story. However, a solid framework can make it easier to draw this distinction.

Any good passive investment strategy should be backed by an extensive body of independent research, and have a decades-long record of success both in the United States and abroad. There are only a few strategies that meet these criteria: value, momentum, low volatility, quality, and to a lesser extent, tilting toward small-cap stocks. If an equity strategy fund does not harness one of these factors, it probably isn't worth investing in.

Alex Bryan has a position in the following securities mentioned above: MTUM. Find out about Morningstar’s editorial policies.