Neena Mishra: The $1.6 trillion ETF industry is presently dominated by plain vanilla market capitalization weighted products that simply replicate the market or a particular segment of the market. With their low-cost and transparent methodologies, they are very popular with investors.
However many investors now demand more than just market benchmark returns from their ETF investments and look for products that have the potential to beat the market. Some of these products sponsors call them “Smart Beta” products though terms like “Advanced or Alternative Beta” appear to be more acceptable in the industry.
With the demand for these products surging, many sponsors are now coming with new products with these “Advanced” strategies. Per IndexUniverse, these ETFs have attracted inflows of $46 billion so far this year, resulting in a 20% increase in AUM. With total assets of $228 billion, this segment of the market now accounts for about 14% of all US listed ETF assets. (Read: 3 Niche ETFs Crushing the Market)
What is Smart Beta?
These indexes attempt to select stocks that have better chances of risk-return performance, based on certain fundamental characteristics or a combination of such characteristics.
While this space offers a number of choices to investors, including simplest equal-weighting, fundamental weighting and volatility/momentum based weighting methodologies, not all these strategies have been able to deliver superior results.
Dynamic ETFs in Focus
The goal of “Dynamic” Indexes is to provide superior risk-adjusted returns by choosing stocks based on investment merit. The Intellidex universe includes 2,000 U.S. stocks, which are evaluated using a proprietary investment methodology based on 25 factors that measure company fundamentals, stock valuation, timeliness and risk.
There is a family of ETFs linked to the Intellidex index strategy across a wide range of categories, including board-market, sectors and industries. Each of these products tracks a corresponding Intellidex Index, delivering access to enhanced index investing. While each incorporates quantitative screening process, different categories have different changes and tweaks to the overall process, according to the sponsor Invesco PowerShares.
Like other “Advanced Beta” ETFs, not all Dynamic Index ETFs have been successful. Below we have highlighted three options—one each from broad-market, sector and industry specific space–that have delivered better results than their market-cap weighted counterparts consistently.
PowerShares Dynamic Market Portfolio (PWC)
Launched in May 2003, this ETF is one of the more popular funds in this category, with over $155 million in AUM. The product seeks to track the Dynamic Market Intellidex Index. It charges an expense ratio of 60 basis points.
It currently holds100 stocks with a focus on large caps. Hess Corp, Valoero Energy, Archer-Daniels and Costco are the top holdings. However the fund is well-diversified with the top holding accounting for just 3.9% of the asset base.