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7 ways to invest with smart beta funds

One of these seven smart beta investment ideas might juice your index fund returns.

  • By Barbara Friedberg,
  • U.S. News & World Report
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Investing in passively managed index funds is a path to market-matching returns. With annualized returns of roughly 9 percent for stock funds and 5 percent for bond funds, most investors do quite well with this investment approach. But there are ways you can do even better. Smart beta funds are exchange-traded funds that veer from the traditional market capitalization-weighted indexes holding securities in proportion to their weight. Smart indexes follow an index but attempt to beat their returns by tweaking the investment holdings in a variety of ways. Here are seven ways you can try to beat the market.

Invest with your values

Scott Sacknoff, CEO at SerenityShares Investments in the District of Columbia, suggests the SerenityShares Impact ETF (ICAN). This fund offers a “dividend-paying basket of stocks diversified across economic sectors and impact activities. The fund considers societal and environmental challenges,” Sacknoff says. With 20 themes that include demographic and societal trends like elder care, recycling and renewable energy, there’s broad attention to faith-based funds and companies that make a difference. The fund has an expense ratio of 0.5 percent, or $50 per $10,000 invested annually.

Use volatility to your advantage

Mannik S. Dhillon, president at VictoryShares and Solutions in Cleveland, says market cap-weighted indexes are too concentrated in a small number of stocks and sectors and that creates a false sense of diversification. His solution is the VictoryShares US 500 Enhanced Volatility Wtd Index ETF (CFO), which tracks an index of the largest U.S. stocks by market cap, and then screens the stocks for positive earnings and weights holdings by volatility. CFO has an expense ratio of 0.35 percent.

Look for value

Value stocks are recognized as long-term outperformers. So, it’s no surprise that the largest smart beta ETF is Vanguard’s Value ETF (VTV) with $69.1 billion in net assets. This smart beta fund simply replicates the holdings in the CRSP U.S. Large-Cap Value Index, which focuses on large-cap stocks that are deemed undervalued. And because it’s a Vanguard fund, the expenses are low at just 0.05 percent.

Bet against the market

If you think the stock or bond market is headed for a fall and want to capitalize, there are factor-based ETFs to accommodate. Short selling is a strategy where shares are borrowed and then immediately sold. Later, the investor buys shares at the lower price and reaps the profit, less commissions and interest. Direxion ETFs offer a complete menu of short smart beta funds including Direxion Daily Total Bond Market Bear 1X Shares (SAGG). This smart-beta inverse bond fund attempts to return 100 percent of the opposite of the performance of the Bloomberg Barclay’s U.S. Aggregate Bond Index. Expenses are 0.45 percent.

Let momentum carry the day

Investment strategies are also ripe for smart beta investing. The iShares Edge MSCI USA Momentum Factor ETF (MTUM) starts with an index of large- and mid-cap U.S. equities. Next, the fund weights the stocks based on price appreciation during six- and 12-month periods. The final screen selects the low volatility stocks over the past three years. The fund boasts a low expense ratio of 0.15 percent.

Equal weight funds deserve a look

The equal weight index is one of the most popular smart beta plays. To counterweight the dominance of the largest stocks in a traditional market weight index fund, the equal weight approach apportions all stocks equally. This gives smaller firms a chance to contribute more to the returns of the fund. The Invesco S&P 500 Equal Weight ETF (RSP) is one of the most popular equal-weight index funds, although its year-to-date return lags the market-cap weighted SPDR S&P 500 ETF (SPY). RSP’s expense ratio is 0.2 percent.

Cash in with dividends

With a volatile stock market, dividends are seen as a cushion for the markets ups and downs. To capitalize on this trend, the SPDR S&P Dividend ETF (SDY) tracks a yield-weighted index of 50 dividend payers from the S&P 1500 Composite Index that have raised dividends for at least 20 consecutive years. The results from the first screen are used to weight the companies by dividend yield. If cash flow is your goal, the 2.4 percent dividend yield is respectable. SDY has an expense ratio of 0.35 percent.

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