Smart beta ETFs that look pretty smart right now

Canadian-listed strategic or “smart” beta ETFs that have outperformed their peers.
Earlier in the week, the CFA Institute Research and Policy Center published a well-written overview of the evolution of index-based strategies, including the rise of smart beta ETFs. Authors Jordan Doyle and Genevieve Hayman propose a conceptual framework that helps investors understand the degree of “activeness” across various investment products (interested readers might look at page 28 of their report, which provides a great overview of the pros and cons of smart beta products).
The framework points to the idea that smart beta ETFs sit somewhere between pure active investing (where a fund manager has full discretion over what is held) and pure passive (such as a traditional index ETF, where there is very little human intervention).
From the pragmatic investor’s point of view, these products offer the advantage of consistent exposure to an investment factor (such as value/growth, dividends, low-volatility and quality), with management expense ratios that are generally lower than that of an actively managed mutual fund or ETF. This advantage, however, quickly becomes the opposite if an investment factor is out of favour (for example, U.S. value stocks in the 2010s), since, by design, the prewritten investment rules don’t change with market conditions.
Today’s screen looks through Morningstar’s database of Canadian-listed ETFs (which now exceeds 1,300 tickers) and looks for those that we’ve identified as using a smart beta approach (which consists of 175 ETFs). From here, I used Morningstar Direct to screen for only those that have received a five-star rating.
It’s vitally important to remember that the star rating (formally known as the Morningstar Rating for Funds) is an objective look-back of after-fee historical risk-adjusted returns relative to category peers. The methodology uses a unique application of utility theory to adjust for risk, recognizing the fact that investors are more concerned about downside risk (when an investment drops in value over a short time) compared with upside risk (when it shoots up quickly).
Mathematically, the rating also puts the most emphasis on the most recent three years of performance history but considers 10 years of data, if available. Morningstar’s data show that, although the rating is backward-looking, aggregate funds that have been rated five-stars end up outperforming those that have been rated four-stars, which outperform those that are rated three-stars, and so on, in periods after receiving the rating.
The funds that qualified in the screen are listed in the table accompanying this article, alongside MERs, categories, trailing performance, inception dates and the “type” of factor exposure each ETF is targeting.
Though not used in the screen, the table also lists Morningstar’s Medalist Rating, which is our view of a fund’s ability to outperform peers on an after-fee basis in the future, based on our analysis of people (quality of the management team), parent (stewardship of the fund company) and process (robustness of investment process). The table is sorted first on the category, then by 10-year total returns.
This article does not constitute financial advice, it is always recommended to conduct one’s own independent research before buying or selling any of the funds or ETFs mentioned in this article.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.