What's the underlying strategy?Some smart beta indices are pretty straightforward, but others are based on complex methodologies. Index components can be weighted by companies’ revenues, dividends, volatility or other corporate variables and skew toward small caps or large caps. Read the prospectus, check out the provider's website and consult an investment professional, if need be, to make sure you're adequately informed before diving in.
How much does this smart beta strategy cost?Investment firms are quick to point out smart beta strategies are typically less expensive than actively-managed funds. That said, they generally cost more than passive, market-cap-weighted indices. Smart beta indices are rule-based and rebalance their holdings on a regular basis to keep their underlying strategy on track. This turnover can increase investor costs. Fees and commissions, even modest ones, eat into returns. So get an accurate read on the fee and commissions structure from the provider.
Be skeptical of back-tested performance claimsMany alternatively weighted index strategies are new products with little in the way of a track record. So ETF providers often do back-testing by applying a mathematical model to historical market data. Such data-crunching can provide useful insights into the potential strengths of a smart beta strategy. Yet, keep in mind that it doesn't predict or guarantee future performance. The same holds true of academic research some financial companies roll out in their marketing materials to promote their products.
What are the liquidity risks with the smart beta strategy?Some smart beta index products are new and may be thinly traded and have wide bid/ask spreads. Also, keep in mind that the liquidity of the underlying components of the product tracking the smart beta ETF is a risk worth considering.
TakeawayThe popularity of smart beta strategies is one of hottest trends in personal investing right now. When designed carefully, these products can give your portfolio a possible performance edge at a reasonable cost. Yet, investors should read the fine print and understand the underlying strategy and risk of any alternative index product. Do the upfront research. It pays to be smart about smart beta. Photo Credit: Pictures of Money via Flickr Creative Commons
The post Stay smart about smart beta appeared first on Smarter Investing Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.