Index investing is an effective way of helping clients get broad market exposure in a low-cost, non-emotional way, according to Som Seif, president and CEO of Claymore Investments Inc. But as advisors embrace exchange traded funds, he says they must ensure the underlying indexing strategy suits their clients’ objectives.

Speaking at the Toronto Stock Exchange on Tuesday, Seif provided an overview of different indexing strategies, including market capitalization-weighted indexing, equal-weight indexing, fundamental weighted indexing and intelligent indexing. Different strategies will be appropriate for different clients, depending on the client’s long-term objectives.

“Not all ETFs are good investment strategies, but there are a lot of ETFs out there,” he said. “What you need to do more and more today is understand what is the underlying strategy, the philosophy of the ETF.”

Added Seif: “If you don’t understand the strategy, you shouldn’t invest.”

Some indexing strategies perform better in certain investing environments, he explained. For instance, market cap weighted indexes perform best when large cap stocks are outperforming, but tend to lag when small caps or value stocks are outperforming.

“They are growth and momentum-based,” Seif said. “It really helps you capture momentum and trends in the market.”

In contrast, equal-weight indexed ETFs give every stock on an index an equal weighting. These types of ETFs tend to perform best when small-cap stocks are outperforming, but they’re slightly riskier because of this greater exposure to small caps. They also face potential liquidity issues, and are less tax-efficient than other ETFs due to constant rebalancing.

Seif recommends using both market cap-weighted ETFs and equal weighted ETFs for tactical market exposure.

Meanwhile, fundamental indexing weights the stocks in an index based on their fundamentals, including sales, book equity value, dividends and cashflow.

“If a company’s fundamentals have improved faster than its stock price has, than you’re going to be rebalancing towards that company,” Seif explained.

This approach tends to outperform other indexes over time, according to Seif. It works best when small caps and value stocks outperform, while it tends to lag when bubbles are forming.

“Really, it’s more of a long-term core exposure,” Seif said. “It’s going to give you a better long term exposure to the markets for the buy-and-hold type investor.”

Lastly, intelligent indexing is a broad category that typically involves the use of quantitative analysis to select the components of an index tracking a specific asset class, such as commodities.

This strategy typically carries less risk than the broader index, and yet in some cases ETFs that are indexed in this manner manage to significantly outperform, according to Seif.

“It’s a better strategy for the long term,” he said.

In general, Seif urges advisors to avoid simply buying a benchmark as an indexing strategy.

“My simple view is that benchmark investing is a bad way to invest,” he said. He doesn’t believe that markets are efficient, and by using the right strategies, he said investors can exploit market inefficiencies to beat the benchmark over the long run.

“If you’re a long-term investor, you should be using the more intelligent and strategic types of products,” he said.