As investors look to outperform the markets, more and more are turning to smart-beta or fundamental indexing to meet their goals. At their core, smart-beta ETFs use various alternative weighting methods, screens, and other factors to craft a rules-based index designed to outperform. Investors seem to like the idea. According to Morningstar, smart-beta products now account for well over one-fifth of the roughly $2 trillion sitting in U.S.-based ETFs and have had three straight years of over $60 billion worth of inflows.
That’s a lot of investor money following into these products in a short amount of time.
But with more than 506 ETFs tagged as smart-beta by ETFdb.com, how do you know which ones are the best? Assets under management could be a great place to start. ETFs don’t get immensely popular without having some real merit behind them.
With that in mind, here are the top 10 smart-beta ETFs you should consider for your portfolio (there are others with high AUM figures that are not on this list due to their similarities to the ones listed here).
1. iShares Russell 1000 Growth ETF
With more than $29 billion in assets, the iShares Russell 1000 Growth ETF (IWF ) takes the cake as the largest smart-beta ETF. IWF is considered a classic growth fund and slices the broader Russell 1000, which holds all the large- and mid-capitalization U.S. stocks, to find stocks that exhibit above-average earnings growth. Historically, growth stocks have traded at higher multiples than other stocks as investors put a premium on the earnings growth. Top holdings include Apple (AAPL) and Alphabet (GOOGL).
IWF has a reasonable expense ratio of 0.20%. The reasonable expenses and focus on faster growers could help explain how the fund has become the largest smart-beta ETF around.
2. iShares Russell 1000 Value ETF
Not surprisingly, IWF’s value-focused twin is the second-largest smart-beta ETF at nearly $26 billion in assets. The iShares Russell 1000 Value ETF (IWD ) seeks stocks in the broader Russell 1000 that show various value metrics. These are stocks thought to be undervalued by the market relative to comparable companies via measures such as P/E, price-book, price-sales and dividend yield. Top holdings for the smart-beta ETF include Exxon Mobil (XOM) and General Electric (GE). Like IWF, IWD charges 0.20% in expenses per year.
3. Vanguard Dividend Appreciation ETF
Dividends have formed the backbone of long-term returns for decades. The key to those returns hasn’t solely been a high yield, but also a constantly growing one. The over $20 billion Vanguard Dividend Appreciation ETF (VIG ) looks at large-cap U.S. stocks that have a history of increasing dividends for at least 10 consecutive years. Its underlying index, the Nasdaq U.S. Dividend Achievers Select Index, screens and kicks out stocks with low potential to increase payouts, as well as REITs that don’t qualify for lower tax rates on dividends. Top holdings include 3M (MMM) and PepsiCo (PEP).
4. WisdomTree Europe Hedged Equity Fund
Most investors are blissfully unaware of just how much currency fluctuations can affect their returns in international stocks. In fact, a strong dollar can actually turn gains in local currencies/markets into losses when looking at a U.S.-based ETF. The $14.7 billion WisdomTree Europe Hedged Equity Fund (HEDJ ) uses currency swaps and futures contracts to mitigate the effects a rising dollar or a falling euro have on a basket of large-cap European stocks. Since HEDJ focuses on the euro currency, the stocks in its portfolio are all from nations in the eurozone. That means it does not hold any stocks from the U.K., Switzerland or other noneuro countries
5. Vanguard High Dividend Yield ETF
While a growing dividend payment is the bulk of the equation, it isn’t the only variable. Having a high yield helps too. The Vanguard High Dividend Yield ETF (VYM ) bets on large-cap stocks that are characterized as having higher-than-average yields. The ETF’s underlying index, the FTSE High Dividend Yield Index, simply screens a broader U.S.-focused index for the companies with the highest yields. That gives the fund a uniquely value-oriented tilt. Over long stretches of time “value” tends to beat “growth.” VYM has $13.4 billion in assets. Top holdings include Procter & Gamble (PG) and JPMorgan Chase (JPM).
Expenses for the dividend smart-beta fund are ultracheap at 0.09%.
6. iShares MSCI USA Minimum Volatility ETF
Another hidden portfolio danger for investors is volatility. The severity of the market’s movements can actually impact total returns over the longer haul. To that end, stocks that exhibit low volatility have provided a better set of returns than those with high volatility. The $10.5 billion iShares MSCI USA Minimum Volatility ETF (USMV ) tracks a basket of U.S. equities with lower volatility characteristics than the broader U.S. equity market. Essentially, USMV seeks to minimize the market’s peaks and valleys. Ultimately, that helps reduce losses during bear markets and allows for gains during bull markets.
7. Guggenheim S&P 500 Equal Weight ETF
The S&P 500 is one of the most widely followed benchmarks in the world. The problem with the index is that it is market-cap weighted. As such, larger stocks in the index get more exposure. This creates an unfair pull on the index, smothering smaller, faster-growing stocks at the bottom. The Guggenheim S&P 500 Equal Weight ETF (RSP ) has a basic approach to fixing the issue; it simply places equal weights on all the stocks in the index. That way Exxon has the same amount of pull on RSP as a smaller stock such as Flir Systems (FLIR). The focus on smaller mid-cap stocks has helped RSP outperform the regular S&P 500 by a few percentage points each year.
8. Vanguard Small-Cap Value ETF
Work by famed economists Fama and French uncovered an interesting phenomenon: “small” and “value” stocks manage to beat pretty much every investment style out there over the long haul. That could help explain why investors have parked roughly $6 billion into the Vanguard Small-Cap Value ETF (VBR ). VBR tracks the CRSP U.S. Small Cap Value Index. The index is a measure of domestic small-caps that meet various “value” metrics. Top holdings include Arthur J Gallagher & Co. (AJG) and TECO Energy (TE).
9. First Trust Dorsey Wright Focus 5 ETF
Not many retail investors focus on momentum, technicals, or relative strength when picking investments. For most, that’s the realm of day traders. However, through smart-beta indexing, investors can access the strategy with the $4.5 billion First Trust Dorsey Wright Focus 5 ETF (FV ). FV seeks to track an index that predicts which sectors have the greatest ability to outperform over a short period of time. FV rotates through these sectors once a month and will only hold the top five in its portfolio. Speaking of that portfolio, FV uses other First Trust ETFs to gain exposure. This uniqueness of strategy allowed the fund to gather assets very quickly.
10. iShares Cohen & Steers REIT ETF
Real estate investment trusts (REITs) have been a popular asset class for years as their high total returns (dividends plus capital gains) have helped them become great performers over the longer haul. The $3 billion iShares Cohen & Steers REIT ETF (ICF ) takes REIT portfolio construction a step further. The smart-beta fund is constructed to provide exposure to real estate companies that are the dominant players in their respective property sectors. That means only the largest apartment owners, mall owners, and office building owners are included. Top holdings include Public Storage (PSA) and Simon Property (SPG).
The Bottom Line
With investors looking to do better than average, more are turning to smart-beta ETFs for inclusion in their portfolios. However, not all smart-beta or fundamental index products will meet their goals. The 10 ETFs listed above have garnered enough assets and have the stamp of approval to stand the test of time. Investors can start their search of great ETFs with this short list in mind.
Disclosure: Author is long FV.