Strategic beta ETFs had $402 billion in total assets at year-end 2014

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Investor demand for strategic beta exchange-traded funds (ETFs) continues to increase, reflecting the continuing appetite on the part of financial advisors and their clients for access to top-quality, quantitative investment expertise through transparent, liquid and low-cost products. According to Morningstar data, strategic beta ETFs had $402 billion in total assets at year-end 2014, and recorded inflows relative to assets of 19%, compared to 13% for their non-strategic-beta counterparts.

Strategic beta ETFs combine the best aspects of active management and passive indexing to help investors achieve specific investment outcomes, such as lower risk, excess returns, more income or greater diversification. Instead of weighting companies in underlying indexes by market capitalization (like most ETFs), strategic beta ETFs either weight companies using rules-based criteria such as cash flow or targeted volatility levels, or equally weight them. In this way, strategic beta ETFs combine elements of actively managed mutual funds with the lower fees and transparency associated with ETFs. The result is a precise investment that can be used to build a better portfolio.

Products Rely on Underlying Index Providers Expertise

Strategic beta ETFs can complement both active and passive products in client portfolios to create more predictable routes for clients to reach their desired outcomes. The keys to their success are the methodologies of their underlying index providers. The precise, targeted nature of strategic beta ETFs require the index providers behind them to be experts. As in the actively managed mutual fund world, the skills, experience and credibility of each strategic beta index provider should be carefully analyzed before investing.

For example, Santa Barbara, Calif.-based equity research shop Sabrient Systems LLC uses a unique quantitative approach to index construction. Sabrients approach combines alpha-producing strategies with strategies seeking beta exposure to sectors, market niches and style boxes. Sabrients approach has demonstrated an enviable record of outperformance. Investment vehicles with over $5 billion in collective assets track them, including our firms Direxion All Cap Insider Sentiment Shares ETF (KNOW), a strategic beta ETF focused on delivering excess returns.