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ETFs uncovered: Should you get into the fast growing sector of ‘smart beta' funds?

by , 15 January 2015

Since their launch in South Africa, the number of exchange traded funds (ETFs) has steadily grown.

One sector of ETFs showing sharp growth is ‘smart beta' funds.

So what are smart beta funds? And should you consider investing in them?

Let's take a closer look…


What are ‘smart beta’ funds?


The aim of smart beta funds is to combine the benefits of passive and active investing in one fund.

Like a passive fund, smart beta funds track an index as closely as possible. This reduces costs.

And, like active funds try to achieve, they try to better the market return by using indices that put more emphasis on certain types of stocks that have a tendency to outperform others.


The three main types of smart beta funds


When it comes to building a smart beta fund, there are three main ways to go about it, Matthew Partridge in Money Week explains…

The first way changes the construction of the broad stock market index.

Instead of weighing each share according to its market capitalisation, the fund manager weighs by fundamental metrics. For instance, weighing by dividends or allocating each share an equal weight. This pushes the fund towards cheaper shares.

The problem with this is it means the fund needs rebalanced on a regular basis to take into account changing fundamentals. This can push up transaction costs, affecting the fund’s returns.

The second way of building a smart beta fund involves holding stocks that meet a specific criteria. So a fund may concentrate just on high yielding stocks or that meet Islamic investment criteria.

But this can lead to an unbalanced fund. For example, it may end up holding a lot of stocks in specific sectors.

The third and newest way to build a smart beta fund uses multiple criteria to screen and rank stocks. But this criteria can lead to a very complex fund, which is hard to decipher. These funds also tend to attract high fees.


Should you invest in smart beta funds?


As with all investments, it’s vital to weigh up each fund on its own merits. Have a look at the performance and fees. There are a number of smart beta ETFs available in South Africa to invest in.

These include the Satrix DIVI ETF and the Grindrod Bank S&P SA DivTrax ETF.

You can look at a fund’s fact sheet online. Weigh up its performance since inception and see how it performs in comparison to its benchmark index.

So there you have it, what you should do if you want to get into the fast growing sector of smart beta funds.

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ETFs uncovered: Should you get into the fast growing sector of ‘smart beta' funds?
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