What are we looking for?
Canadian-listed strategic or smart beta exchange-traded funds that have outperformed their peers.
The screen
As mentioned in a prior column, the number of actively managed ETFs in Canada has surpassed the total of passively managed ones. This contrasts with the United States, where passively managed assets overtook actively managed assets for the first time last year. In Canada, the split between actively managed assets and passively managed assets in the retail space is roughly 85 per cent to 15 per cent, according to Morningstar’s data.
The debate between active and passive investing will likely continue for years to come, but investors certainly cannot wait that long to invest. The good news is, for investors who have strong conviction on a particular investment style in the coming years, smart beta ETFs might be a reasonable solution. These products typically rely on a predetermined set of trading rules to gain consistent exposure to an investment factor. Examples of such factors include value, growth, income, volatility or risk, and quality.
By using a set of rules (often built into a published index), smart beta ETFs provide active exposure at a fraction of the cost of an actively managed fund. The advantage of this type of product is also their disadvantage: They are consistent. Hence, if a particular investment style (such as value in the decade after 2010) falls out of favour, the fund does nothing to correct course.
To provide some ideas to investors with a high conviction for a particular investment style (or combination of styles), I screened the Canadian-domiciled universe of smart beta ETFs (there are now 181) looking for ETFs that have:
- Received a five-star Morningstar Rating for Funds (also known as the “star” rating), indicating that a fund has historically outperformed peers in its category after fees, on a risk-adjusted basis. Our data shows that although the star ratings are backward-looking, as a group, funds that have received five stars outperform those that have received four stars, three stars and so on in periods after receiving the rating. In other words, it’s more likely that a fund manager with a track record of outperforming peers will continue to outperform in the future, as compared to managers who have historically underperformed peers.
- Received a Morningstar Medalist Rating of gold, silver or bronze, highlighting funds that Morningstar believes will produce excess after-fee returns 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 decision making).
What we found
The ETFs that qualified in the screen are listed in the table accompanying this article, alongside fund categories, management expense ratios, trailing performance, inception dates and ratings. Also displayed is the investment factor each fund is pursuing. Investors are urged to look first at the fund category, given that the rating of each ETF is meant to measure performance against category peers.
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.
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