A Decade Of Dominance For An Unheralded ETF

Count 2016 as another year of impressive growth and expectations of more of the same for smart beta exchange-traded funds.

BlackRock data indicate 2016 is proving to be a banner year for smart beta funds. As of November 20, smart beta ETFs around the world attracted $45 billion in new assets compared with $30 billion for all of 2015, according to BlackRock.

Smart Beta And PRFZ

“The percentage of asset owners reporting that they are currently evaluating smart beta has doubled since 2014 and 2015 levels. This growth has come from asset owners who had not previously evaluated smart beta, as well as from asset owners who have evaluated smart beta in the past, but who choose not to implement, and who, we believe, are again evaluating smart beta,” according to FTSE Russell.

Often noted in the smart beta discussion is that the concept is not as young as many investors think. In fact, some of the most successful smart beta ETFs have been around for a more than a decade. Just look at the PowerShares FTSE RAFI US 1500 Small-Mid PRFZ. At 10 years and three months old and home to over $1.6 billion in assets under management, PRFZ is neither young nor small.

“Overlooked” or “unheralded” might be the better descriptors for this smart beta ETF. PRFZ tracks the FTSE RAFI US 1500 Small-Mid Index, which delivers exposure to a broad swath of mid- and small-cap stocks.

Selective Strategy

PRFZ member firms are “are selected based on the following four fundamental measures of size: book value, cash flow, sales and dividends. Each of the equities with a fundamental weight ranking of 1,001 to 2,500 is then selected and assigned a weight equal to its fundamental weight,” according to PowerShares.

Smart Beta's Frequent Critique Countered By PRFZ

One of the criticisms of smart beta is that it is only durable or profitable in select market environment and that traditional indexes win over the long term. PRFZ proves the fallacy of that notion.

“From its Sept. 20, 2006, inception through Nov. 30, 2016, PRFZ generated a 9.59 percent annual return — outperforming its benchmark, the Russell 2000 Index, by 218 basis points,” said PowerShares in a note out this week. “PRFZ has also proven to be efficient from a tax [...] and overall cost perspective. PRFZ has not distributed any capital gains since inception, and its net expense ratio is 0.39 percent (0.41 percent gross expense ratio).

"This means that the vast majority of the fund’s returns have accrued to the investor. Notably, these excess returns have not just been sporadic. Since inception, PRFZ’s underlying index has posted a three-year rolling win rate of 94 percent relative to its benchmark, the Russell 2000 Index.”