Are "Smart-Beta" ETFs Active or Passive?

According to BlackRock data, global exchange traded product assets in what has been widely known as "smart beta", has grown nearly 40% annualized rate since 2012, twice the rate of the broader industry. While inflows for dividend-focused products slowed in the first seven months of 2015 to just $1.1 billion, after $19 billion and $17 billion in 2013 and 2014, respectively, hurt we think as investors prepare for higher interest rates, demand has been strong for other single and multi-factor products.

During last week's S&P Capital IQ ETF analyst hour on active vs. passive strategies, the topic of how smart beta fits in came up via an audience question. Aye Soe, senior director of S&P Dow Jones Indices, responded that her firm's dividend indices are transparent and follow a passive rules-based approach. Meanwhile many active managers screen based on dividends, but they overlay various valuation criteria in putting together their portfolios. (S&P Capital IQ operates independently from S&P Dow Jones Indices.)

A replay of the ETF analyst hour can be viewed here or watch a short video recap here. 

For example, SPDR S&P Dividend (SDY) tracks the S&P 1500 Dividend Aristocrats index. That index currently consists of 100 companies that have raised their dividends annually for 20-or-more consecutive years. Valuation is not relevant for continued inclusion, but companies are reconsidered annually based on their dividend growth history. The ETF has a 0.35% net expense ratio. Despite outflows in 2015, SDY has $13 billion in assets.

In contrast is TCW Relative Value Dividend Appreciation (TGIGX), an actively managed equity income mutual fund. Manager Diane Jaffee and team screen a large-cap universe for dividend paying stocks that are trading at a discounted valuation due to modest earnings growth but have catalysts such as cost cutting initiatives or recent management changes. TGIGX has a 1.1% net expense ratio, which is slightly below the 1.2% equity income Lipper peer group.

Another group of single factor ETFs are those constructed with a quality focus. iShares MSCI USA Quality Factor (QUAL) has $1.1 billion in assets despite launching just over two years ago. The MSCI index behind this ETF consists of companies with high return on equity, stable year over year earnings growth, and low financial leverage. QUAL has a 0.15% net expense ratio and is rebalanced semi-annually.

QUAL's approach is different than PowerShares S&P 500 High Quality Portfolio (SPHQ), an older yet smaller ETF with $525 million in assets; both experienced inflows in the first seven months of 2015. Companies inside SPHQ have above-average S&P Capital IQ Quality Rankings, a metric based on consistently growing earnings and dividends over a ten-year period. Relative to QUAL, SPHQ has more exposure to consumer staples (18% of assets vs. 7%) and less exposure to information technology (5% vs. 32%). SPHQ has a 0.29% net expense ratio.

Please follow me @ToddSPCAPIQ to keep up with the latest ETF Trends.

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