Are Smart Beta Funds Worth The Higher Cost?

by: Jason Kelly

In this video, I'll explore whether smart-beta funds are worth their higher cost.

Smart-beta funds have become popular. They try to replicate various investing techniques, such as value and growth, with an automated formula.

Here's how the funds were explained in a March 18, 2017, Buttonwood column in The Economist:

[Excerpt shown at 0:35.]

While it may be true that smart-beta funds are cheaper than active fund managers, it's important to remember that active fund managers aren't worth much. Most of them lose to plain Jane indexes. So, we have to see whether smart-beta funds are worth their higher cost compared with standard index funds.

We'll use the Russell 1000 index, which consists of the largest 1,000 companies from the Russell 3000 total US stock market index. It's like the S&P 500, but with 1000 companies instead. The index is available in its plain form from iShares with symbol IWB. Its smart-beta growth version uses symbol IWD, and value uses IWF. Here are their expenses:

[Chart shown at 2:51.]

The plain Jane index fund, IWB, charges a net expense ratio of just 0.15%, while value [IWD] and growth [IWF] charge 0.20%. Smart-beta is 33.3% more expensive.

Has it been worth it? Let's have a look.

[Charts shown at 3:40.]

Sometimes value wins, sometimes growth wins, but you can't know which in advance, so own the whole index.

Which have investors chosen? Value and growth, of course. AUM: IWB $18B, IWD $36B, IWF $34B.