Why investment experts are excited about Smart Beta ETFs

More and more advisers are using smart beta strategies, according to the VanEck Smart Beta Survey, which found that 50% of advisers are using it in their portfolios, up from 37% last year.

The survey also shows that smart beta is being used as a replacement for actively managed funds by 64% of financial advisers and brokers.

"The survey reveals smart beta strategies are quickly gaining traction among investment professionals,"says Arian Neiron, managing director of VanEck Australia.

"We are nearing a tipping point where smart beta exchange traded funds will become as prevalent as market-cap-weighted ETFs given their strong performance and cost advantages compared to active funds."

But what exactly are smart beta ETFs? Smart beta aims to combine elements of passive index investing and active fund management. The funds track customised index benchmarks that seek to either improve performance or alter the level of risk relative to a traditional index benchmark.

There are a few advantages in buying smart beta ETFs.

Instead of paying active management fees, you pay lower fees for exchange traded products (ETPs) that are listed on the ASX. Rather than not knowing what an active fund manager invests in, the ETP reveals all the investments for investors.

They are still more expensive than traditional market-cap-based index investments though, and there may be higher index constituent turnover and associated trading costs.

Smart beta ETFs are all very different so it is hard to compare. You need to understand how each one invests before you commit your money.

There are four common smart beta approaches to building indices, explains robo adviser Stockspot in its 2017 Australian ETF Report.

These are:

• High-dividend strategies that aim to pick stocks with higher dividend yields to boost investor income; e.g. Vanguard Australian Shares High Yield (ASX: VHY).
• Other fundamental indices that focus on measures like sales revenue or free cash flow as a more accurate measure of economic contribution rather than using market capitalisation; e.g. Russell Australian Value (RVL) or BetaShares FTSE RAFI Australia 200 ETF (QOZ).
• Equal weighting - the simplest form of index construction that just averages an entire universe of stocks, thus giving each stock the same importance, e.g. VanEck Vectors Australian Equal Weight (MVW).
• Low-volatility strategies that target a smoother ride by carefully selecting less risky stocks; e.g. ETFS S&P 500 High Yield Low Volatility (ZYUS).

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