How to Select Strategic-Beta Exchange-Traded Products (Part 2)

How we separate the wheat from the chaff in this field.

Ben Johnson 18.12.2019
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In part 1 of this article, we looked at the costs and some factors of strategic beta ETPs. Here we will continue the discussion from other perspectives.

As I mentioned before, there are a host of other factors that have been discovered ranging from borderline silly to serious contenders. The latter include quality and low volatility. Both factors are relative newcomers, and neither has been as fully vetted as value and momentum. Of course, that hasn't prevented index and ETF providers from launching a raft of products aimed at delivering them in a readily investable form.

Quality is closely related to profitability, which, along with investment, is a component of the Fama-French five-factor model.[2] Profitability passes the intuition test. After all, the present value of a stock is a factor of its future cash flows: The more profitable the firm, the greater its expected cash flows. From a behavioral point of view, it can be argued that investors tend to underestimate the sustainability of firms' current profitability or otherwise misprice profitable stocks. Quality and profitability have been put to work by the likes of Dimensional Fund Advisors and AQR in their fund lineups. Quality is in vogue in ETF-land, too, as demonstrated by the $10.8 billion in net new inflows into quality-focused U.S. large-cap ETPs over the past three years.

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Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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