CHICAGO, Nov 12 (Reuters) – Holding stocks in a passive
index fund as a core portfolio holding has generally been a
rock-solid idea. You can own nearly the entire market at a low
cost and not get snagged in market timing errors.
Yet most index funds are capitalization-weighted, meaning
they hold the most popular stocks by market value. That could
lead to owning the most overpriced stocks, which may incur more
downside risk when the market heads south.
A better alternative could be to own “smart-beta” funds.
While still built on indexes, the stocks within these baskets
are often picked for their cash flow, book value, dividends and
sales. That means instead of picking all of the potentially
over-valued stocks that have won the market’s latest beauty
contest, more fundamental measures are applied.
Generally, smart-beta funds emphasize large stocks with
healthy dividends that may not be everyone’s favorite at the
moment. Their portfolios may include a healthy dose of older,
defensive and dividend-rich companies in manufacturing,
utilities, healthcare and financial services.
The strategy behind smart-beta funds also leans toward
fundamental indexing that relies on identifying the
most-consistent companies year after year in terms of top-line
sales growth and cash flow.