Smart-beta ETFs have been the fund industry's latest passion. That's not usually a good thing: A rush of new funds in a particular area is usually a prelude to a long period of buyer's remorse from investors and mockery from the press. So how have all those smart-beta funds done recently?
Actually, not so bad. The Standard & Poor's 500 stock index gained 17.2% the 12 months ended March 31, while the average smart-beta fund gained 18%.
"To the extent that a lot of strategies are ways to get more exposure to small-company stocks and value stocks — they all take different paths — those bets have paid off in the past 12 months," said Ben Johnson, director of passive fund research at Morningstar.
Most of the top-performing smart- beta funds were small-company stock funds, such as iShares Russell 2000 Value (IWN), up 29.3%, and PowerShares Russell 2000 Equal Weight ETF (EQWS), up 26.9%. The S&P SmallCap 600 index gained 24.6%.
NOT JUST SMALL CAPS
But loading up on small caps wasn't the only way to get to the top of the heap. PowerShares S&P 500 High Beta ETF (SPHB) was the top performer for the past 12 months, soaring 32%. The fund invests in the 100 most volatile stocks in the S&P 500 and weights them equally. (Equal weighting tends to give a fund a small-cap bias as well.) The fund's top holding was Chesapeake Energy, up 44% the past 12 months. It sports a beta of 2.37.
Many of the top-performing smart beta funds also had a value tilt. First Trust Rising Dividend Achievers (RDVY), is another equal-weighted fund. The fund holds the stocks of 50 companies with a history of increasing dividends every year, and that have a likelihood of continuing to do so. No one sector can constitute 30% of the fund's holdings, which keeps it from being composed primarily of dividend stalwarts like real estate investment trusts and utility stocks.
The First Trust offering, up 27% in the past 12 months, clobbered a similar fund, ProShares S&P 500 Dividend Aristocrats (NOBL), which gained 9.7% during the same period. The Dividend Aristocrats have raised their dividends every year for 25 years, and also limits sector exposure to 30% of the portfolio. But the First Trust offering's portfolio has higher sales and growth, on average, than the ProShares fund.
Given the strong market returns the past 12 months, it should be no surprise that those ETFs that aimed to reduce risk produced subpar returns. Smart-beta ETFs that invested in low-volatility stocks, such as PowerShares Low Volatility ETF (SPLV), for example, lagged as the stock market roared ahead in the aftermath of the presidential election. The fund gained 10.1% — not a bad return, but well below the S&P 500.
Smart beta is still a young trend, and there are certainly chances for several of them to stink up the place. But a preliminary look at smart-beta ETF records bodes well, Mr. Johnson said. "Looking at the large value smart-beta ETFs, the funds have actually done quite well."