How Smart Beta Works for Other Asset Classes - Part 1

Smart beta exchange-traded funds (ETFs) have become increasingly popular over the past several years. In fact, BlackRock projects that smart beta ETFs will grow at a 20% annual pace to $1 trillion in assets under management by 2020. Investors looking for a mix between passive and active strategies have embraced these ETFs to achieve specific outcomes – such as low volatility or high yields – at relatively low expenses across a wide range of asset classes.

In this article, we’ll look at smart beta ETFs and how investors can leverage them to achieve their investment objectives in any asset class.

Smart Beta Is More Than Equities

Most smart beta ETFs have focused on the equity markets given their deep liquidity, but investors can find many other asset classes under the smart beta umbrella. For example, the PowerShares Fundamental High Yield Corporate Bond Portfolio ETF (PHB B) provides exposure to high-yield corporate bonds that are weighted based on their credit quality rather than the face value of the debt – a seemingly much more logical methodology.

Here are some examples of popular smart beta ETFs across other asset classes:

Alternative ETFs

Name	Ticker	Expense Ratio	Strategy
WeatherStorm Forensic Accounting Long-Short ETF	(FLAG B-)	0.92%	Quality of financial statements.
IQ Merger Arbitrage ETF	(MNA A)	0.76%	Merger opportunities.
Hedge Replication ETF	(HDG B-)	0.95%	Replicates risk/return of hedge funds.

Bond ETFs

Name	Ticker	Expense Ratio	Strategy
PowerShares Fundamental High-Yield Corporate Bond Portfolio ETF	(PHB B)	0.50%	Credit quality of the bond and issuer.
Vident Core U.S. Bond Strategy ETF	(VBND B)	0.48%	Valuation and momentum.
IQ Enhanced Core Plus Bond U.S. ETF	(AGGP )	0.25%	Price momentum.

Commodity ETFs

Name	Ticker	Expense Ratio	Strategy
ETRACS Bloomberg Commodity Index Total Return ETN	(DJCI B)	0.50%	GSCI index with caps to limit exposure to any single commodity.
iPath Pure Beta Broad Commodity ETN	(BCM B+)	0.75%	Proprietary roll timing and selection.
GS Connect S&P GSCI Enhanced Commodity TR ETN	(GSC C+)	1.25%	Proprietary weighting of the GSCI index.

Currency ETFs

Name	Ticker	Expense Ratio	Strategy
PowerShares DB U.S. Dollar Index Bearish Fund	(UDN A-)	0.80%	Short (inverse of) the U.S. dollar.
PowerShares DB G10 Currency Harvest Fund	(DBV A-)	0.80%	Carry trade opportunities.
iPath GEMS Asia 8 ETN	(AYT B-)	0.89%	Local currency exposure across eight emerging Asian economies.

Multi-asset ETFs

Name	Ticker	Expense Ratio	Strategy
WisdomTree Dynamic Bearish U.S. Equity Fund	(DYB )	0.48%	Short (inverse of) U.S. equities.
iShares Morningstar Multi-Asset Income ETF	(IYLD A)	0.60%	Proprietary exposure to multiple asset classes.

Preferred Stock ETFs

Name	Ticker	Expense Ratio	Strategy
SuperIncome Preferred ETF	(SPFF B-)	0.58%	Yield of preferred stock.
VanEck Vectors Preferred Securities ex-Financials ETF	(PFXF B)	0.40%	Removes exposure to financial sector.

Real Estate ETFs

Name	Ticker	Expense Ratio	Strategy
iShares Cohen & Steers REIT ETF	(ICF B-)	0.35%	Dominance in respective property sector.
Lattice Real Estate Strategy ETF	(RORE n/a)	0.45%	U.S. REITs with favorable valuation, momentum and quality.

How Do Smart Beta ETFs Compare?

Smart beta ETFs can’t always be directly compared to their benchmarks since their investment objectives may differ. For example, the PowerShares S&P 500 Low Volatility ETF (SPLV A) may have underperformed the S&P 500 SPDR ETF (SPY A) over the past year, but it has a beta coefficient of just 0.59 compared to SPY’s 1.00. Investors looking for less volatile exposure to equities may therefore view SPLV as the superior option.

SPY vs. SPLV Performance — Source: Google Finance

In the chart above, the S&P 500 SPDR ETF (SPY A) outperforms the PowerShares S&P 500 Low Volatility ETF (SPLV A), but the latter fund exhibits significantly less volatility during downturns, which helps even out returns over time.

A good way to quantify these differences may be to use risk-adjusted measures of return, such as the Sharpe ratio. The S&P 500 SPDR ETF’s (SPY A) three-year average Sharpe ratio stands at 0.82, according to Morningstar data as of December 1, 2016, while the PowerShares S&P 500 Low Volatility ETF’s (SPLV A) Sharpe ratio is 1.05, suggesting that it has a higher risk-adjusted rate of return despite its lower actual return.

In other cases, direct comparisons should be taken with a grain of salt. A good example is comparing the PowerShares Fundamental High Yield Corporate Bond Portfolio ETF (PHB B) to a traditional high-yield corporate bond fund like the iShares iBoxx High-Yield Corporate Bond ETF (HYG A). The HYG fund may have a higher yield than PHB, but the credit quality of PHB’s portfolio is superior and could provide greater risk-adjusted returns.

Investors carefully read smart beta ETF prospectuses to understand the weighting methodologies used and keep those factors in mind when comparing the funds with their market capitalization-weighted counterparts.

Finding the Right Smart Beta ETFs

Investors can find a complete list of smart beta ETFs on ETFdb.com, which provides a great starting point for research. For a deeper analysis on individual ETFs, the ETF Analyzer tool outlines a fund’s holdings and compares it to similar funds in the space.

The Bottom Line

Smart beta ETFs have become increasingly popular across all asset classes – not just equities. Investors should carefully read a smart beta ETF’s prospectus to understand the weighting method employed and look beyond simple total return comparisons. These funds may provide a great way to diversify a portfolio and enhance long-term risk-adjusted returns.

For more information about the pros and cons of smart beta ETFs, read From Passive To Active? Smart Beta Takes Off.

Further Reading
To learn more about how smart beta affects the main asset classes in more detail, check out the rest of our Smart Beta in other asset classes series.