Darrick Hutchens, a CFP and the founding partner of and an advisor at Hutchens & Kramer Investment Group in Carmel, Ind., loves smart beta ETFs.
After starting his firm in 2014, following a job based at a regional bank, he shifted away from having his clients in managed funds and started using ETFs in a big way in client portfolios.
But Hutchens quickly realized that he could help clients outperform the market by turning to so-called smart beta ETFs.
These products, though based on existing indexes, make alterations in weightings in a transparent, rules-based manner that seeks to achieve better performance over the long term than the underlying index, said Ben Johnson, director of global ETF research at Morningstar.
And they are cheap.
“The only significant added cost [is] the index licensing fees,” Johnson said.
“I’m a math guy, and these smart beta ETFs are math-driven, and I know that at the end of the day math wins and emotion loses,” Hutchens said.
He favors smart beta ETFs that have a track record, noting that because they are transparent, he can also back test them to well before they were launched.
What Hutchens finds is that “they generally outperform the underlying index over any multi-year period you look at.”
For example, one of the most basic smart beta ETFs takes the S&P 500 and simply equal weights all the constituent stocks, instead of assigning them a proportion of the index equal to their market share, he said.
Back-testing that strategy, Hutchens said that it has consistently outperformed the S&P 500 itself over the past 10 years for any period except for 2014 taken alone.
“It makes sense,” he said.
“Consider that the top four companies in the S&P -- Apple, Microsoft, Exxon and Johnson & Johnson -- account for almost a tenth of the index, yet that’s not where the growth will come from,” Hutchens said.
“You have all these companies down in the bottom 5% of the S%P, and down there is where the next Apple is, sitting down there at the bottom. Yet with an S&P index fund, you don’t have any real exposure to it,” Hutchens said.
“On balance, smart beta funds may beat the market, but you need to hold them over a long period of time, because their performance will be lumpy and inconsistent,” Johnson said.
Hutchens said that he is leery of more recent smart beta ETFs in what is an expanding market of the products.
“The fees are rising, and the track records are short, so I try to keep my betas pretty simple,” he said.
Dave Lindorff is an award-winning veteran journalist, a Columbia University Knight-Bagehot Fellow in Business Journalism, a two-time Fulbright Professor to China and spent five years as a correspondent in Hong Kong covering China and Hong Kong for Business Week magazine.
This story is part of a 30-30 series on smart ETF strategies.