What are we looking for?
“Smart beta” exchange-traded funds that have outperformed peers.
The screen
Though not nearly as topical as they once were, smart beta ETFs have recently shown strength in their performance. More aptly named strategic beta, these ETFs straddle the line between active and passive management, but using a set of predetermined rules to systematically invest in stocks that fit a fundamental investment style. Examples of common styles would include value, growth, dividends, quality, momentum, low volatility or a combination of several. For investors, the benefit of these products is twofold: They offer active exposure to investment factors at a fraction of the management fee, and the exposure to the factor(s) is consistent over time, given the strategy itself is driven by a set of fairly rigid rules. On the downside, strategic beta ETFs will not change course if a particular factor is out of favour, unlike an active manager who can shift investment styles between value and growth depending on their view of the market.
Recently, I noticed that the proportion of strategic beta ETFs that outperformed their peers skewed noticeably on the positive direction. By looking at the distribution of Morningstar’s star rating (an objective look back at risk-adjusted returns after fees relative to peers), I noticed that of the 142 or so strategic beta ETFs from Canadian-domiciled fund companies, 51 (or about 36 per cent) have received four or five stars, indicating that they have outperformed peers, while only 39 (or about 27 per cent) have underperformed their respective peers. To explore ideas in this space further, I screened for the top-performing smart beta ETFs, denoted by a Morningstar rating for funds (star rating) of five stars. Our data show that although the star ratings are backward-looking, funds that have received five stars as a group outperform those that have received four stars, three stars, and so on in periods after receiving the rating.
What we found
The funds that met the above requirements are listed in the accompanying table, which includes management expense ratios, performance and category names. Also displayed is the “strategic beta group,” an indication of the investment factor being pursued, as indicated by prospectus filings. From this, we can see that many of these ETFs have a focus on dividends. Finally, the table also displays Morningstar’s “medalist” rating. Though not used in the screen, the medalist rating reflects Morningstar’s forward-looking assessment of an investment’s ability to produce after-fee alpha in the future, noting that many of the funds on this list are rated gold, silver or bronze, indicating that we believe they will produce positive after-fee alpha.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA