CHICAGO – When advisors or investors choose index funds, the obvious appeal is broad diversification and low cost. But many fund providers want to try to improve on that in hopes of better returns by adding an active component to otherwise passive funds.

As so-called smart beta or strategic beta funds are capturing market share, some industry experts worry that advisors or investors may not have enough information about the costs or the potential risks.

To address that, Morningstar has introduced a classification system to help investors better identify, compare and analyze these exchange-traded products.


"The need to define, measure and scrutinize the strategic beta space has increased as investors have flocked to these products and they've grown more complex,” Ben Johnson, Morningstar's director of manager research for passive strategies, said at the Morningstar ETF Conference.

“Investors need to undertake the same degree of due diligence when evaluating strategic beta products as they would for active investment managers. We've created a strategic beta classification system to help investors identify the strategies that straddle the active/passive divide," Johnson added.

Smart beta funds are different in that instead of solely choosing investments based on their stock market capitalization within an index, strategic beta fund managers choose in a variety of different ways – for example, picking stocks with increasing dividends, lower correlation or lower volatility. Proponents say such funds can bring better returns and/or lower risk.


As of June 30, Morningstar identified 673 strategic beta ETPs in its database, representing approximately $396 billion in assets worldwide.

Using its new system, advisors and investors can identify, screen and search for ETPs at three strategy levels. The investment research giant says the system first identifies strategic beta products as the investment style, then by the strategic objective of the underlying benchmark and then the strategic objective at a more granular level.

For example, strategies that try to improve returns or isolate a specific source of return relative to a benchmark, such as value, growth, momentum, etc. Other screens include risk-oriented factors, such as low volatility and low correlation.

“Our new system for classifying strategic beta investment products will help investors understand their options and make more informed investing decisions. Because strategic beta products exhibit a variety of investment styles, the Morningstar classification system can help investors compare similar strategies and evaluate investments within the context of their traditional Morningstar category," Johnson said.

He added that the new classification system could help lead to “fee compression” and “price competitiveness” as advisors and investors had new tools to compare investment choices.

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