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exchange-traded funds

John DeGoey, portfolio manager with Industrial Alliance Securities, chose two Vanguard ETFs as his smart-beta picks.JENNIFER ROBERTS/The Globe and Mail

Investors can bet on beating the market thanks to so-called "smart beta" exchange-traded funds, or ETFs. Their goal is to outpace plain vanilla indexes such as the S&P/TSX Composite or S&P 500 by offering lower-cost access to strategies normally used by active fund managers.

To improve performance, smart beta ETFs screen for companies that meet the criteria for one or more investment "factors," such as share-price momentum, undervalued stocks or smaller-cap companies.

Keep in mind that investing in these ETFs means taking on additional risk. There is no guarantee they will outperform in the longer term, and there may be periods when these funds lag the traditional benchmarks.

To help navigate this investment niche, we asked three experts for their picks among smart-beta offerings.

Christopher Davis, director of research at Morningstar Canada, Toronto

  • The pick: iShares Edge MSCI Multifactor Canada Index ETF
  • Management expense ratio (MER): 0.50 per cent

This Canadian equity ETF tracks an index based on four potential drivers of return, so you get "factor diversification," says Mr. Davis. "I would be reluctant to bet on one factor in the Canadian market," he says. "For example, the small-cap effect [where smaller companies outperform larger peers over time] has been really strong in most places of the world but not in Canada." While one factor "may outperform over time, there can be long, long stretches where it doesn't," he noted. This ETF tracks 80 stocks compared with almost 250 in the S&P/TSX Composite, and includes names such as Industrial Alliance Insurance and Financial Services Inc. in its top 10 holdings. Its fee is not cheap when compared with a traditional index ETF, but it is an alternative to a higher-cost, actively managed mutual fund, he said.

  • The pick: iShares Emerging Markets Fundamental Index ETF
  • MER: 0.72 per cent

This ETF, which tracks undervalued securities in developing countries, is "more of a contrarian play," says Mr. Davis. Emerging-market stocks have been hurt by China's slowing economy and the oil-price crash. While it makes sense to invest in an asset class that has "performed poorly over a longer stretch," emerging markets are also trading relatively cheaply on a historical basis, he added. This fund screens for stocks based on business fundamentals such as dividends, cash flow, sales and book value. Top holdings include the iShares India 50 ETF, iShares MSCI Taiwan Capped ETF, Petroleo Brasileiro S.A. (Petrobras) and China Construction Bank Corp. This ETF is pricey but still cheaper than the emerging-markets mutual funds held in fee-based investment accounts, which charge an average of 1.55 per cent, he noted.

Daniel Straus, ETF analyst at National Bank Financial, Toronto

  • The pick: WisdomTree International Quality Dividend Growth Dynamic Hedged Index ETF
  • Management fee: 0.63 per cent (MER not finalized)

This ETF, which owns dividend-paying, developed-market companies outside North America, is one way for Canadian investors to add diversification to their portfolios, says Mr. Straus. Launched in July, the ETF holds names such as Unilever NV, British American Tobacco PLC and Airbus Group SE. Consumer discretionary and industrials are the biggest sector weightings. Because returns from international stocks can be hurt by declines in the local currency's value, this ETF tries to offset that risk, he said, with a flexible currency strategy whereby it can hedge, not hedge or partially hedge depending on market or economic conditions. While the fund's fee may be slightly higher than some of its peers, its use of a dynamic hedging strategy "could represent pretty good value," he said.

  • The pick: First Asset Morningstar U.S. Value Index ETF (Unhedged)
  • MER: 0.66 per cent

For investors concerned about rising valuations in the U.S. market, this ETF tracks underpriced stocks, says Mr. Straus. It screens for companies trading at a low price to earnings, cash flow and book value. National Bank economists and strategists continue to see opportunity in the United States, which is "still showing favourable long-term economic trends, such as improving strength in its labour market," he said. Top holdings include Nelnet Inc., JetBlue Airways Corp. and Assured Guaranty Ltd. An unhedged ETF is a better bet because the U.S. dollar could climb relative to Canada's loonie in a rising interest-rate environment, he said. The fee charged by this ETF is reasonable for a tactical short-to-medium-term holding when paired with a cheaper fund that is a core position in a portfolio, he said.

John DeGoey, portfolio manager with Industrial Alliance Securities in Toronto and author of The Professional Financial Advisor III

  • The pick: Vanguard Global Value Factor ETF
  • Management fee: 0.35 per cent (MER not finalized)

This ETF, which invests in companies large and small around the world, is appealing because it tracks stocks trading cheaply relative to fundamentals, says Mr. DeGoey. "The evidence is overwhelmingly clear that value stocks outperform growth stocks over statistically significant time-frames," he said. "People [also] should be taking a global perspective because Canada only represents 3 or 4 per cent of the world's stock-market capitalization." This ETF, which was launched in June, is about 43 per cent invested in financial stocks. Top holdings include Carnival Corp., Prudential Financial Inc. and Citigroup Inc. While the MER could come in at slightly above 0.35 per cent, it should eventually come down because Vanguard has consistently shown it lowers fees when its funds grow in size, he noted.

  • The pick: Vanguard Global Momentum Factor ETF
  • Management fee: 0.35 per cent (MER not finalized)

This ETF, which screens for stocks with recent strong performance, appeals to investors who are "optimistic in the short term," says Mr. DeGoey. "The phrase that people use in the business is 'the trend is your friend'… Companies that have done well in the past tend to continue to do well because they have momentum in earnings." This ETF, which tracks small-to-large developed companies around the globe, could complement a value-oriented ETF holding, he said. Value and momentum investment factors typically outperform in different time periods, he noted. Top holdings include Applied Materials Inc., Amazon.com Inc. and Facebook Inc. The fee is pricier than a traditional index ETF, but it is not meaningful when compared with an actively managed mutual fund, he said.

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