Instead of tracking the S&P 500 through a traditional capitalization-weighted index exchange traded fund, investors can access the broad U.S. markets through "enhanced" or "smart-beta" index funds that try to mimic actively managed investment styles.
These smart-beta ETFs deviate from traditional large-cap indexing, adhering to standard formulas or set investment rules instead, reports Conrad De Aenlle's for MarketWatch. Beta refers to the measure of volatility, or systematic risk, of a holding compared to the overall market.
De Aenlle points out that smart-beta ETFs Guggenheim S&P 500 Equal Weight (NYSEARCA:RSP) and PowerShares FTSE RAFI U.S. 1000 Portfolio (NYSEARCA:PRF) provide investors with broad exposure to U.S. markets but offer superior returns.
Year-to-date, RSP has gained 16.5% and PRF is up 17.0%. In comparison, the S&P 500 Index returned 14.4%. Since 2006 when PRF first started trading, the PRF and RSP have generated total cumulative returns of 62% and 60%, respectively, compared to the 33% gain in the S&P 500.
Traditional large-cap indices, like the S&P 500, have a higher stake in companies with larger market values. Looking at the largest components, these companies no longer enjoy big growth spurts and their stocks may even be overvalued.
Consequently, the smart-beta index ETFs try to underweight large caps and include value stocks over growth stocks.
However, smart-beta funds are most costly than the traditional index-based ETFs. RSP and PRF both have an annual expense ratio of 0.40%, whereas traditional beta-index ETFs come with an expense ratio of 0.10% or lower.
Additionally, enhanced index ETFs show slightly higher volatility due to their greater tilt toward mid- and small-cap allocations.
Max Chen contributed to this article.
Additional disclosure: Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates.