Are you looking for a low cost way to reduce risk or increase return within your portfolio? If so, you might consider adding a “Smart Beta” fund to your holdings. Smart Beta funds are an exciting new investment opportunity as they allow those who believe in the benefits of indexing to access strategies beyond the traditional market capitalization weightings without having to seek out active managers.
Smart Beta funds have garnered a lot of attention lately as one of the most rapidly growing areas in Exchange Traded Funds (ETFs). In the U.S. alone, there are approximately 850 Smart Beta ETFs that are collectively worth over $500 billion. These are impressive numbers for a product that was virtually unheard of several years ago. With all of the attention that Smart Beta is receiving, we wanted to provide a few thoughts to keep in mind when considering these products.
- What is Smart Beta? Smart Beta is just one of many terms for a series of similar products. Other popular monikers include Active Beta, Enhanced Indexes, and Factor Investing, and new ones are still popping up from time to time. Many of these terms can be used interchangeably as they refer to a product that is designed to track an index in a way that incrementally increases returns or reduces risk within a portfolio over time.
- How is Smart Beta different from regular indexing? Smart Beta funds improve risk-adjusted returns by applying alternative weighting methods. Traditional indexing ETFs track an index whose members are weighted based on the market value of the companies. Smart Beta funds seek to implement an investment strategy within the fund and weight the members accordingly. For example, a common Smart Beta strategy is dividend products that weight members according to dividend yield (i.e. the higher the dividend yield, the more weight the company will have in the fund). Other popular fundamental strategies include weighting companies by high quality, low volatility, momentum, or value.
- How is Smart Beta different than active management? Smart Beta funds are rules-based and transparent. These funds have predetermined criteria for how they are constructed and systematically rebalanced. Essentially, this means there is no “stock picking” within the funds. The main advantage of the rules-based approach is that it removes active decision making from the process and ensures that the fund strategy remains consistent with the investor’s objectives. The predetermined criteria and index like methodology of Smart Beta funds also has the benefit of keeping fees low.
Although the term Smart Beta was coined within the last several years, the underlying principles of the products are not new in practice. Many of the fundamental investment strategies that have driven the development of Smart Beta funds have been researched and applied in academic and professional settings for decades. More recent technological advancements and the widespread adoption of ETFs as an investment vehicle have allowed these strategies to be packaged into a product that is cost efficient and easily tradable. Smart Beta funds are an interesting new tool that APCM has conducted extensive research on. We are looking forward to sharing more of our conclusions with you in the near future.