An ETF That Cements The Case For Smart Beta

The term smart beta, as it pertains to exchange-traded funds, has been derided by critics, but the success of some of the funds occupying this corner of the ETF landscape is undeniable.

According to FTSE Russells first U.S. retail financial advisor market survey Smart Beta: 2015 survey findings from U.S. financial advisors 68 percent of financial advisors polled are using smart beta ETFs and 70 percent are using multiple strategic beta approaches.

A recent survey by Create-Research found that smart beta ETFs account for over $300 billion, or 18 percent of the U.S. ETF market, by far the largest ETF market in the world.

The PowerShares FTSE RAFI US 1000 (ETF) (NYSE:PRF), which celebrated its tenth anniversary in December, is one of the ETFs that should be credited with bringing credibility and momentum to the smart/strategic beta ETF movement. A track record of more than a decade and $3.75 billion in assets under management confirm as much.

Looking Closer At PRF

PRF was born in the days around the bursting of the technology, which torched many portfolios because the sector had become an excessive percentage of supposedly diversified broad market funds. At one point, during the halcyon days of the late 1990s/early 2000s tech bubble, the sector represented a third of the S&P 500.

As the dust settled following the collapse of the technology bubble, PowerShares recognized the shortcomings of market-cap weighting. To address this issue, PowerShares began laying the groundwork for a lineup of ETFs that combined attributes of both passive indexes and active management. Originally called 'intelligent indexes,' this suite served as the genesis for what would later become known as smart beta strategies.

Based upon objective, rules-based index methodologies, these strategies break the link between price and portfolio weight in the index construction process and employ a systematic rebalancing mechanism that serves to remove investor behavioral biases and emotion from the investment process, according to a new note from the issuer.

Today, PRF, which holds nearly 1,000 stocks, allocates over 20 percent of its weight to financial services stocks while six sectors command weights of 10 percent to 12.2 percent. PRF's underlying benchmark, the FTSE RAFI US 1000 Index, is comprised of stocks selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends, according to PowerShares.

A frequent criticism of smart beta ETFs, one PRF has endured, is that they either overemphasize the value factor or the small-stock factor. About half of PRF's holdings can by considered value stocks but less than 6 percent are small-caps.

Regardless, it would be foolish to dismiss the ETF's long-term returns.

Since inception, PRF has posted a three-year rolling win rate of 78 percent over its benchmark, the Russell 1000 Index. That means that over three-year rolling windows, the underlying index has outperformed the Russell 1000 Index nearly 80 percent of the time, said PowerShares.

Image Credit: Public Domain