This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Schwab Enters Smart-Beta ETF Space

NEW YORK (TheStreet) -- As the exchange-traded fund industry has evolved, one area that has received a lot of attention has been "smart beta."

Smart-beta funds tweak an existing broad-based, market cap-weighted index such as the S&P 500 to target specific stocks. For example, a smart-beta fund might target low-volatility stocks, or high-volatility stocks, or momentum stocks or stocks with certain fundamentals.

The first smart-beta fund was the PowerShares FTSE RAFI US 1000 ETF (PRF), which has been trading for almost eight years.

PRF is a large-cap fund that weights holdings by size, book value, cash flow and dividends. Since its debut, PRF has not outperformed the S&P 500 all of the time, but it has outperformed the benchmark most of the time.

Last week Charles Schwab entered the smart-beta space with the following funds:

Schwab Fundamental US Broad Market Index ETF (FNDB) SYMBOL="FNDB" EXCHANGE="NYSE" PRIMARY="NO"/>

Schwab Fundamental US Large Company Index ETF (FNDX)

Schwab Fundamental US Small Company Index ETF (FNDA)

Schwab Fundamental International Large Company Index ETF (FNDF)

Schwab Fundamental International Small Company Index ETF (FNDC)

Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE)

Schwab has a unique place in the ETF industry. It typically isn't first to market with any type of fund, but it is immediately important in every niche it enters because it offers its ETFs commission-free to its large customer base.

The indices underlying the new Schwab funds were created by Russell Investments based on work done by Rob Arnott at Research Affiliates, the same firm whose research is behind PRF along with many other funds offered by PowerShares.

The Schwab funds will track only three quality factors: retained operating cash flow, adjusted sales and the extent to which a company returns cash to shareholders through dividends or buybacks.

The big question is whether all of this is worth the effort. The answer is a resounding probably. Schwab executive Tony Davidow is quoted in an article at IndexUniverse saying that these funds potentially offer a smoother ride for ivnestors.

Although there can be no absolutes, many of the smart-beta funds perform as expected most of the time.

For example, the PowerShares S&P 500 Low Volatility Portfolio (SPLV) has been less volatile and has outperformed the S&P 500 from its inception up until the last three months. SPLV has 29% in utilities, which are interest rate-sensitive, so the recent Fed taper talk that set off panic in the bond market also adversely affected the utilities sector and, by extension, SPLV.

No smart-beta approach can be the best performer for all market conditions, just as the traditional market cap-weighted SPDR S&P 500 (SPY) cannot be the best performer for all market conditions. As mentioned, SPLV lagged when rates spiked. PRF, by virtue of its ranking process, tends to be heavier in financial stocks than the regular S&P 500 as it was in 2008, and so it went down more than the benchmark during the financial crisis.

These biases are usually easy to spot when looking at a fund's composition, and the new Schwab fundamental ETFs will also have them. The Schwab Fundamental Emerging Markets ETF has a combined 33% in energy and materials, compared with 20% in those sectors for the iShares MSCI Emerging Markets ETF (EEM). This does not make it a bad fund, but if those weightings persist, then at some point it will be a drag on the fund's returns because occasionally resource-related stocks will lag.

The point is not about trying to predict when an oversized exposure to a county or sector will be a problem but to understand what might cause a given fund to struggle. Then you can make a decision about fund that could be overly sensitive to interest rates, such as SPLV.

At the time of publication, Nusbaum had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,563.30 -317.06 -1.88%
S&P 500 1,930.67 -39.40 -2.00%
NASDAQ 4,369.7730 -93.1290 -2.09%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs