Smart Beta ETFs: Bridging the Gap Between Active and Passive
This article was originally published on ETFTrends.com.
Investors who are considering ways to diversify an investment portfolio should consider smart beta exchange traded funds that combine the best of historically backed active styles with the efficient and cost-effectiveness of a passive index-based product.
"By combining active and passive investment techniques, smart beta seeks to take advantage of market inefficiencies in a rules-based and transparent manner," according to New York Life MainStay Investments, IndexIQ.
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Specifically, smart beta ETFs, like traditional passive funds, passively reflect the performance of an underlying index. However, the new breed of smart beta ETFs track a rules-based indexing methodology that is reminiscent of the actively managed investment approach that tr8ies to exploit profitable positioning.
The strategies are designed to take advantage of inefficiencies created by traditional market capitalization-weighted indices. One approach used by smart beta ETFs centers on investment factors, which try to contribute to the potential outperformance of a broad index while maintaining its passive indexing methodology.
By isolating different performance characteristics, investors can attempt to target specific results or combine factors to optimize a portfolio. The most common characteristics or factors include momentum, low volatility, size, value, quality and dividend yield. These factors have been academically proven to help investors generate improved risk-adjusted returns over the long run, or diminished drawdowns during periods of volatility while maintaining their upside potential.
Potential investors should keep in mind that these single factors may exhibit cyclical trends. Nevertheless, investors may gain exposure to multiple factors in an attempt to smooth out the ride and gain broader, factor-based coverage for a diversified investment portfolio.
"Portfolio. Whether using a single- or multi-factor approach, it is important to note that factor performance is cyclical in nature—which means that no one factor is consistently more favorable than any other. Since each factor can potentially outperform or underperform the market in any given period, diversification continues to play a key role in factor investing," according to IndexIQ.
To help investors better access potential opportunities in the U.S., IndexIQ has partnered up with Chaikin Analytics to launch the multi-factor IQ Chaikin U.S. Small Cap ETF (NasdaqGM: CSML) and IQ Chaikin U.S. Large Cap ETF (NasdaqGM: CLRG). The smart beta ETFs incorporate the so-called Chaikin Power Gauge that combines four primary factors, including value, growth, technical and sentiment.
The value factor includes screens like LT debt to equity ratio, price to book value, return on equity, price to sales ratio and free cash flow. Technical factors cover price trend, price trend rate of change, relative strength vs. market and volume trend. Growth factors include earnings growth, earnings surprise, earnings trend, projected P/E ratio and earnings consistency. Lastly, the sentiment factor screens for earnings estimate trend, short interest, insider activity, analyst ratings and industry relative strength.
For more information on smart beta ETFs, visit our smart beta category.
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