Pure Passive ETFs
Smart Beta ETFs
Trading decisions can make the difference
We have noticed some investors evaluating smart beta ETFs the same way they view pure passive ETFs, based on their understanding that both are seeking to track an index and have similar risks. However, smart beta ETFs make many more assumptions and generally require a custom index; pure passive ETFs generally do not. There are many active investment construction decisions being employed in smart beta. Therefore, we believe smart beta should be evaluated more like active ETFs. However, a key difference between smart beta ETFs and active remains and is worth emphasizing: active ETFs allow the portfolio manager to trade – rebalance, add, or remove individual securities – when they believe the time is right, rather than on a predetermined basis. This is a key potential advantage that the buyer receives with active management.
A note of caution
Both smart beta ETFs and active ETFs are relatively sophisticated investment vehicles that pose risks. Passive ETFs also pose risks, but they may offer a more straightforward story to investors and financial professionals who are researching allocation options. If the goal is to try and protect investors from the potential risks of active investment decision-making and product construction, investors and financial professionals may want to consider using the same product review process for smart beta ETFs that they use for active ETFs.
2 Smart beta refers to an investment style where the manager passively follows an index designed to take advantage of perceived systematic biases or inefficiencies in the market. Smart beta strategies involve risk, including risk of loss.
3 A capitalization-weighted (or “cap-weighted”) index is a stock market index whose components are weighted according to the total market value of their outstanding shares.
4 A debt-weighted (or bond market) index is a method of measuring the value of a section of the bond market, computed from the prices of a selection of bonds, typically a weighted average.
5 A weighted average is an average resulting from the multiplication of each component of a set by a factor reflecting its quantity or importance.
Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the ETF's net asset value. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Active ETF: Unlike typical exchange-traded funds, there are no indexes that an active ETF attempts to track or replicate. Thus, the ability of an active ETF to achieve its objectives will depend on the effectiveness of the portfolio manager. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.