Dividend ETFs vs. Smart Beta

By Senior Investment Analyst, John Koch on December 17, 2015

The latest article by David Dziekanski for ETF.com (12/14/16), “Older Dividend ETF Strategies Are Fading” is eyebrow-raising–to say the least.

I won’t get into the lauding of smart-beta ETFs by the author, because it feels like there is enough discussion in the media about the new wave of smart-beta products. You can decide for yourself whether the merits of smart beta rings true based on your own investment philosophy. For what it’s worth, iSectors has not yet fully jumped into the smart beta pool–you might say we have “dipped our toes in the shallow end” for now.

I’d much rather discuss the points that were made at the expense of traditional dividend ETFs, such as SDY – the SPDR S&P Dividend ETF (iSectors Domestic Equity Allocation owns SDY, as well as the iSectors Global Allocations). Basically, funds like SDY were smart beta ETFs before that term was invented. It feels slightly unfair to lump them into the same bucket as the quasi-active smart beta funds that exist today.

For example, the author of the article writes, “A long track record is not always a good thing for smart-beta ETFs. Active management can tweak their approach over time. Indexes can, in some cases, get stale.”  How can a long track record be a bad thing? Without a long history of returns, how will an investor know a fund’s results during real life market situations?

All other things equal, if choosing between two investments, one with a short track record and one with a long track record, won’t the investment with the longer track record always be the right choice? And isn’t that due to the fact that there is automatically less uncertainty due to its record over full market cycles that has been witnessed?

Although funds like SDY have much simpler processes than many smart beta funds that exist today, continuing to stick to a strategy, as simple as it may be, should not be considered a bad thing. Especially because dividend ETFs were not originally constructed to be quasi-active like many of the smart beta funds that have just recently come into existence.

This isn’t meant to be a dig at smart beta. Smart beta funds often offer the kind of innovative ideas that no one ever dreamed of when SDY was created in 2005. But to think that the usefulness of a good old-fashioned dividend weighted ETF is lessened just because there are newer options available doesn’t agree with the lessons that the stock market itself has taught us over the years. The market has taught us that the next step is always unpredictable, but that longer-term history often repeats itself.

There will always be a place in a portfolio for an investment that you can look back to see how it has performed in different market conditions, while currently using the same philosophy that it did so since the beginning. This is why iSectors will be sticking to the old guards like SDY even if it might be “fading” according to some.

Let me know what you think…

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