Your guide to evaluating strategic beta ETFs


Strategic beta exchange-traded funds (ETFs), especially factor-based strategies, have become more common in recent years, making thorough due diligence an important step in evaluating them. Asking questions like those included here is an important step to help you evaluate the most suitable strategic beta ETF and better navigate the complexities associated with certain strategies.

General strategic beta strategies

Questions to ask Things to consider
Is the index methodology understandable and transparent?

A transparent index methodology should clearly explain index construction. Vague language may imply greater complexity and uncertainty in what is supposed to be a “rules-based” index.

  • Can the issuer explain the index methodology enough for you to fully understand it? If not, consider a more straightforward alternative.
How much history does the index have?

Having sufficient history allows you to analyze how the index performed during various market cycles, especially relative to cap-weighted indexes.

  • Verify if the index was newly created. If historical data is displayed, investigate whether it is actual versus hypothetical performance.
  • If the index was created by the ETF issuer to launch a product, confirm if the index was based on an existing active strategy. If so, make sure you understand any differences.
How does the strategic beta strategy fit in a portfolio?

The ETF issuer should present a clear story and purpose behind the strategy’s usage in a portfolio.

  • Determine if the strategic beta ETF can serve as a complement or a replacement to cap-weighted ETFs.
  • Understand what, if any, differentiation the strategic beta ETF provides compared to cap-weighted ETFs in terms of size, sector and factor tilts.
  • Keep in mind that a fund that looks “inexpensive” may actually be “expensive” if it offers little to no diversification from a low cost cap-weighted ETF.

In the example below using the MSCI Factor Box, you can see the factor diversification obtained in value, momentum, quality, yield and growth, by combining a value-oriented strategic beta ETF (Fund A) with a cap-weighted ETF (Fund B).

Chart comparing MSCI factors

For illustrative purposes only.

What is the ETF’s closure risk?

Checking the ETF’s closure risk is imperative, especially for strategies with lots of competition, such as multi-factor ETFs, which have proliferated in recent years.

  • To determine an ETF’s closure risk level:

    • Check if the ETF’s assets and liquidity are sufficient for long-term survival
    • Check the issuer’s history with ETF closures
    • Check the competitive landscape to determine the ETF’s viability in its category
How cost efficient is the strategy?

Cost efficiency is an important element in achieving investment goals over time.

  • Compare the ETF’s expense ratio to ETFs with similar strategies from the same Morningstar Strategic Beta category, but avoid choosing a fund solely based on fees.
  • Look at the ETF constituents’ size and liquidity. Smaller, less liquid stocks may carry disproportionately large portfolio weightings in certain strategies, potentially leading to wider ETF bid/ask spreads and higher costs to transact in block sizes.

Complex factor-based strategies

Questions to ask Things to consider
How does the index provider define each factor?

Index providers often consider different metrics, or “ingredients” in creating factor-based indexes. For example, various value-tilted indexes may diverge in sector exposures (and performance) based on the metrics employed to create the value tilt.

  • Check the index methodology to verify and understand the metrics used to create the factor tilts.
How are factors combined?

Among multi-factor ETFs, there is great difference in how many and which combination of factors are employed.

  • Check how many factors the index is targeting, and make sure the combination of factors employed aligns with your objectives.
Quality, low volatility, size, yield, momentum, value
How are factor exposures weighted?

Some multi-factor strategies provide equal exposure to each factor. Some overweight/underweight certain factors. And others may periodically shift the factor exposures “dynamically” based on models.

  • Understand how much exposure (or weight) is given to each factor in constructing the index.
factor exposure weights
How is the index constructed?

Multi-factor indexes are constructed using an isolated (top-down) or integrated (bottom-up) approach, which can impact the factor characteristics of the index.

  • An isolated approach starts with the creation of several single factor indexes that are usually equal-weighted to create a “master” multi-factor index.
  • An integrated approach often measures each constituent based on a number of factors, then selects and weights the constituents based on an aggregated “factor score.”
Chart comparing isolated vs integrated models


Be in the Know - Get news, insights and education delivered right to your inbox.


What to read next

Discover ETF Know:How

Browse our full-spectrum curriculum of ETF tools and resources designed to help you boost your knowledge and gain a competitive advantage.

Comparing strategic beta, active and passive

Understand the differences between active, passive and strategic beta strategies and see how they complement each other when building a portfolio.

Compare ETFs

Use Morningstar’s fund explorer to compare any mutual fund or ETF to what Schwab offers.