Smart beta continues to confound advisers

Ill-named strategy finds place between passive and active

Jan 25, 2016 @ 12:01 am

By Jeff Benjamin

+ Zoom

Still trying to figure out what smart beta means? You're not alone.

“Today's biggest trend is not smart beta, it's wishing we had a better name for it than smart beta,” said Jim King, managing director in ETF portfolio management at Guggenheim Investments.

“My issue with smart beta is that it tends to over promise,” Mr. King said Sunday as part of his presentation at the Inside ETFs conference in Hollywood, Fla.

Smart beta is loosely defined as a passive investment strategy that aims to outperform traditional market-capitalization indexes. To do this, they adhere to rules based on other factors, such as their dividends, volatility, price momentum or even by avoiding some sectors altogether.

The problem with investing in traditional indexes is that those indexes tend to favor large-cap growth stocks, some experts said. Remove Apple Inc. (AAPL) from the S&P 500 Index, for example, and it would have to be replaced by 102 of the smallest-capitalization stocks in the index in order to make up for the lost market capitalization, said Mr. King.

Consequently, smart beta funds and ETFs tend to come with more risk.

“Smart beta is riskier than market-cap weighting because smaller-cap and value tilts will add volatility, but that can be dealt with through implementation,” Mr. King said. “Over a full market cycle, any methodology is likely to out-perform market-cap weighting.”

Kicking off the four-day annual gathering, smart beta was highlighted as one of the recurring themes, driven largely by what is seen as a general lack of understanding from investors and financial advisers.


A survey of 250 financial advisers, conducted by conference host, found that 43% of respondents have less than 5% of client portfolios allocated to smart beta strategies, and 42% have zero allocated.

Meanwhile, 41% of adviser said they plan to increase their allocations to smart beta in the next year.

In terms of the greatest potential benefits of smart beta strategies, 33% said higher returns than cap-weighted indexes, 22% said less risk than cap-weighted strategies, 21% said greater diversification, and 17% said lower correlation to traditional cap-weighted indexes.

But when asked to chose from a list of popular smart beta strategies, 38% of respondents selected “none of the above.”

The survey concluded that the fact that “none of the above” was the most popular answer “could indicate an opportunity for smart beta managers to further educate investors.”

Michael LaBella, a portfolio manager at QS Investors, who spoke along with Mr. King about smart beta, acknowledged smart beta has become a sometimes confusing fit between passive and active strategies.

“Now we have smart beta, but investors need a map or a field guide to figure it out,” he said. “These strategies could be vastly different, but they're all called smart beta.”


He proposed looking at smart beta through the lens of outcome-oriented solutions that would include core, defensive, value and momentum.

“We should be talking less about passive versus active, and instead be solving for investor outcomes regardless of what it's called,” Mr. LaBella said. “Expectations are key for investors to be able to utilize smart beta.”

Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ, concurred with the speakers that the name smart beta is a problem, but not the only problem.

“Nobody likes the term smart beta, but everybody uses it because that's what everybody knows it as,” he said. “We would say that investors shouldn't be looking for smart beta, they should be looking for funds that have certain characteristics.”

At its core, any smart beta strategy is just an index fund with factors to alter the traditional market-cap weighting, which puts it in an odd place between active and passive investing.

“Smart beta encompasses a lot of things, and we've gotten to the point where the term smart beta is almost too broad to be useful,” said Michael Iachini, managing director of mutual fund and ETF research at Charles Schwab Investment Advisory.

“The main challenge is, most investors don't know what they're getting if all they know is the term smart beta,” he added. “It's most useful at a conference like this where we can tell advisers what we're talking about, but for an actual investor the name smart beta doesn't matter.”


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