Smart Beta ETF's seem to promise what all investors are seeking: higher returns and lower risk. That should prompt skepticism.
Michael Sprung, President and Chief Investment Officer of Sprung Investment Management Inc. tells investors that should be highly sceptical when considering new investment products that seem to good to be true.
The financial engineers of Bay and Wall Streets love coming up with new jargon. Typically these terms have more to do with marketing and selling new products than with sound investment principles. The latest one to be bandied about by the ETF industry is "Smart Beta"
Beta is a measure of the volatility, or systematic risk of a security or a portfolio in comparison to the market as a whole. The term "Smart Beta" is now being appended to crop of new exchange traded funds (ETF's). They seem to promise what all investors are seeking: higher returns and lower risk. That should prompt scepticism.
Index ETF's are 'capitalization-weighted', meaning that stocks in the funds are weighted in proportion to their market capitalization. For example, in a fund that tracks the S&P/TSX Composite Index, Royal Bank, with a market capitalization of $105.66B, will form a higher proportion of the fund than Westjet, with a market capitalization of $2.97B.
In smart beta funds, the component weightings are based on other criteria, such as valuations, dividends, momentum or volatility. By a curious coincidence these are the same sort of criteria that active managers use to look for stocks. Of course, active managers use these criteria simply as a screen: stocks that meet a given criteria are then subject to thorough analysis prior to being selected. In a smart beta fund all stocks that meet the criteria are included in the fund.
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