Despite their advantages, on average, these funds haven't been a clear improvement over their cap-weighted counterparts.
A version of this article appeared in the June 2017 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here.
Strategic-beta exchange-traded funds track indexes that make rules-based, active bets in an attempt to deliver better returns, less risk, or some combination of the two as measured against a conventional broadly diversified, market-cap-weighted index.
As of the end of May, there were 637 strategic-beta exchange-traded products that collectively held $619 billion of investors’ assets. Here, we will assess the track records of strategic-beta ETFs across the Morningstar Categories that make up the U.S. equity Morningstar Style Box.
The manner we’ve chosen to measure these funds’ success--or lack thereof--mimics the methodology of Morningstar’s Active/Passive Barometer (we featured a summary of the findings of our most recent Active/Passive Barometer in the March issue of ETFInvestor). In each of the nine categories included in this analysis, we measure individual strategic-beta ETFs’ performance relative to an equal-weighted benchmark of their category peers that track more-traditional market-cap-weighted benchmarks.1
We believe this approach is more pragmatic than sizing these funds up against a single index as it: 1) incorporates the net-of-fees (and other costs) performance of investable alternatives and 2) avoids issues that might arise from cherry-picking a single index as a yardstick (that is to say, results may vary widely depending on the index selected as a basis for comparison). Thus, our approach reflects the real-world performance of funds available to investors and accounts for the diversity of methodologies and resulting performance profiles across seemingly similar indexes.
We compared the performance of each strategic-beta ETF that existed at the beginning of the one-, three-, five-, and 10-year periods ended March 31, 2017, with the equal-weighted performance of their more-vanilla peers. For purposes of calculating success rates, a strategic-beta ETF is considered to have succeeded if it: 1) survived to the end of the period and 2) outperformed the equal-weighted composite of its cap-weighted counterparts. The results of this exercise appear in Exhibit 1.
Success rates across the nine categories we examined are mixed. Large-cap strategic-beta ETFs have generally fared better relative to their mid- and small-cap peers. For the 10-year period ended March 31, 2017, 84% of large-cap strategic-beta ETFs outperformed their average cap-weighted passive peer, while just 29% of their mid-cap and 33% of their small-cap counterparts managed the same feat. The most note-worthy results were produced by strategic-beta ETFs in the large-value category, where success rates were greater than 50% during the trailing three-, five-, and 10-year periods.