Smart beta exchange-traded funds are trendy, but they have high fees and high risk.

Investment styles vary widely from passive do-nothing approaches to hyperactive day trading. Everyone attempts to find and market the “Holy Grail,” but there is no substitute for hard work, knowledge and discipline. Passive investing has become wildly popular ever since Vanguard founder, John Bogle, launched the first index strategy in 1975.

Today, low-cost indexing using exchange-traded funds is so mainstream that even Warren Buffett recommends the approach for individuals who don’t have the time or discipline to pick individual securities. The concept is simple: Emulate the overall market as cheaply as possible.

Now, some index strategies are beginning to deviate from traditional market capitalization-based approaches to alternative methods known as “smart beta.” Instead of allocating portfolios by a company’s size (i.e. Standard & Poor’s 500 index) or stock price (Dow Jones Industrial Average), these portfolios are constructed based upon other metrics, such as book value, dividend yield or volatility, in order to outperform the market. “Smart beta” strategies have grown rapidly, attracting $271 billion in assets, which accounts for about 17 percent of all ETFs.

However, what investors really end up with is a bet against the market, otherwise called active investing – the antithesis of passive investing. Here are four reasons to be cautious about the investment industry’s latest marketing ploy and why “smart beta” should not be confused with index investing.

1. “Smart beta” outperformance comes from taking on more risk. There’s no such thing as a free lunch. One of the more popular “smart beta” styles is to equally weight an index like the S&P 500 index. By doing so, investors end up with more exposure to smaller companies instead of large ones. Historically, small-cap stocks have outperformed large-cap stocks, but a primary reason is because they have higher volatility, or price risk. This is great to have in a bull market but exposes you to additional downside risk during market declines.

Another common form of “smart beta” strategies is to weight a portfolio towards value-based metrics, such as dividend yields, book value or low P/E ratios. However, value stocks are cheap for a reason. The firm could be encountering significant competitive pressures or have a highly levered balance sheet with elusive profits. In other words, many value stocks have higher business risk.

Unlike traditional active strategy managers, “smart beta” strategies aren’t digging into why these stocks are cheap. Instead, they are blindly relying on the past performance of value stocks versus growth.

2. “Smart beta” can lag for prolonged time periods. Many of these strategies have short track records and are largely based on backtesting. Although “smart beta” strategies can show hypothetical outperformance over long time periods, there are also prolonged stretches of underperformance. For example, an MSCI study of 20 years of performance history found that investing towards small caps lagged the broader market for as much as six straight years.

Value investing underperformed for a 3-year stretch, and low volatility stocks did the same for two years. Though it may be trendy to overweight high-dividend stocks when interest rates are near record lows, this may not be the case in the future.

A core reason why Buffett recommends index strategies for nonprofessional investors is that they tend to make the wrong decisions at the worst time (buying high and selling low). Investors in “smart beta” strategies have to be disciplined enough to ride out these periods of underperformance.

3. “Smart” can be expensive. Many smart ETFs charge higher fees than traditional index strategies. In some cases, fees can be eight times or greater. Not only does this give companies an incentive to push these types of products regardless of whether it meets an investor’s objectives, but it is guaranteed to work against you. The only thing paying a higher fee makes certain is that you pay a higher fee.

Moreover, it is not unusual for turnover rates to be more than double those of traditional index strategies, especially for ones that are equally-weighted. High turnover creates additional trading costs and becomes a hidden fee, which requires that the “smart beta” strategy take on even more risk in order to beat the broader market.

4. Smart beta is n ot an alternative to active management. Reporters have likened smart beta ETFs to a “more mechanical cousin” of stock pickers. To be clear, a good analyst will look for fundamental qualities similar to the smart beta metrics. Some of the strategies search for above average dividends or a history of share repurchases. Others may apportion weights based upon cash flow generation or value based on P/E. Unlike a fundamental ETF, merely uncovering an undervalued stock that generates significant cash flow doesn’t necessarily warrant inclusion in the portfolio.

The future growth of those cash flows is important, the rationale behind the valuation cannot be ignored and the long-term thesis must be persuasive. Rigid adherence to a predetermined set of fundamentals ignores the nuances of a particular business or a particular industry. An analysis of a bank requires a different set of tools than a utility company does. A good analyst discriminates with company specific criteria in a way that a mechanical algorithm is unable to do.

Investors considering “smart beta” strategies need to fully understand the associated risks and costs of these ETFs. Most importantly, they should not be confused with index investing. My personal belief is that investors who wish to outperform the market are better served by seeking talented money managers who actively manage risk and have a solid track record rather than relying on a portfolio that’s constructed based on historical returns with little to no knowledge about the underlying securities.

Brett Carson , CFA, is the director of research for Carson Institutional Alliance where, as portfolio manager, he is directly responsible for managing several strategies, including perennial growth, long-term trend and write income. Additionally, the Omaha-based research department conducts thorough analyses of companies to identify undervalued stocks that carry attractive upside potential.

Investment advice offered through CWM, LLC, a Registered Investment Advisor.