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Content provided by Rusty Vanneman, CFA, CLS Chief Investment Officer

Smart beta ETFs, sometimes known as strategic beta ETFs, represent the fastest-growing segment of the booming ETF landscape – and for good reasons.

In 2014, smart beta accounted for $170 billion in assets, according to a report for Institutional Investor by Howard Moore. The concept goes back decades, but the popularity of smart beta ETFs is rooted in the risk-averse aftermath of the 2008 financial crisis. As Moore writes, with interest rates near zero, bond yields sluggish, and an equities market that “has ramped up disproportionately to economic growth,” investors need new ways to get returns, but they still don’t have the stomach for risk. Smart beta ETFs can meet that need. There are rules-based portfolios typically based on factors that have been studied to show they can have long-term performance advantages. They provide transparency and the potential for higher returns without too much risk.

At CLS, we believe smart beta ETFs have distinct advantages for a couple reasons.

First, they provide the essence of active management at a fraction of the cost. That’s the reason they are taking market share from actively managed mutual funds like crazy. For instance, why buy a mutual fund with an expense ratio of 1.50% per year, when you can buy an ETF largely doing the same thing (such as value investing or dividend investing) at 0.25% per year? That’s a mighty big head start for the smart beta ETF’s potential performance. In addition, smart beta ETFs don’t have a portfolio manager waking up on the wrong side of the bed or getting sick. It closely tracks indexes by itself. If the biggest key to investing success is discipline – and it is – then an ETF staying on top of its benchmark and following its investment philosophy and process to the T is about as disciplined as it can get.

Second, smart beta ETFs will likely also take market share from vanilla, cap-weighted ETFs. Why? Because smart beta ETFs in theory (and historically) have a performance edge, or at least most of them do. Factors such as quality, size, or value have all shown they can add incremental value over the long term (though, like all investments strategies, they can underperform over shorter time periods).

We use smart beta ETFs at CLS, and we will likely continue to increase our use of them in the years ahead.


The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change.  No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  You should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.
An ETF is a type of investment company whose investment objective is to achieve the same return as a particular index, sector, or basket. To achieve this, an ETF will primarily invest in all of the securities, or a representative sample of the securities, that are included in the selected index, sector, or basket.  ETFs are subject to the same risks as an individual stock, as well as additional risks based on the sector the ETF invests in. Beta is a measure of the volatility, or systematic risk of a security or a portfolio in comparison to the market as a whole.