Exchange Traded Funds – A Simple Idea That Continues to Evolve

Written by: Marty Shields

As is often the case with new products or services, they start off simple when they are first launched but over time they evolve and frequently become more complex and sophisticated to meet the needs and demands of the buyer.  This evolution can bring dramatic improvements over the original model but not all the changes are always needed and some changes are better than others.

This week, Ryan, Steve and Marty went to the ETF.com annual conference which is the largest global conference focusing on Exchange Traded Funds.  It is four days of intense education on everything pertaining to ETFs.   One of the major themes of the conference is the evolution of index funds being created by market capitalization of the companies in the index (like the S&P 500 or the Nasdaq) to being constructed by alternative strategies.  This concept is often referred to as “Smart Beta” and the list of parameters that can be used to determine the index fund is almost endless.  The upside to this evolution is that an index is an arbitrary basket of stocks or bonds and in many cases using the market weight does not always provide the best risk adjusted return versus other factors that can be used to construct an index.

In our client portfolios, we use both market cap and smart beta funds.  One of the smart beta funds we use is a fundamental index which determines the stocks to be used based on the retained operating cash flow, adjusted sales, and dividends plus stock buy backs of companies.  By using these criteria to build an index you select companies that are reasonably valued but have good growth opportunities and thus are potentially good investments.

As the number and type of ETFs continues to expand it becomes ever more important to engage a firm such as Bouchey Financial Group or to do extensive research yourself to make sure the ETF you are selecting is the best one for a particular asset class in your portfolio.