It's no secret that strategic-beta exchange-traded products have become a pervasive part of the marketplace, rewarding investors with innovative tools to diversify and fine-tune portfolios in ways traditional market-capitalization-weighted indexes don't allow.
As access to sophisticated strategies has become democratized in recent years, advisers now can wield more control over how they seek income or minimize risk for clients.
The astounding growth of these products — there were 950 with assets of $478 billion worldwide as of the end of last year, according to Morningstar Inc. — is a testament to the benefits of a transparent, low-cost exchange-traded fund structure with a clear, documented methodology that comfortably marries elements of passive and active management.
But with that rapid proliferation comes the surprise that advisers often overlook strategies that are not abundantly employed by funds or simply pass over ones that don't immediately appear to fit anywhere in their clients' precision-crafted portfolios.
INSIDER-SENTIMENT STRATEGY
One particular excess-return strategy that has not become ubiquitous but has shown consistent outperformance involves a remarkably simple idea: Investors who want to outperform the market should take cues from corporate insiders who have access to key information.
Those executives, directors and major shareholders can give clues to the health of a company based on their own publicly available stock activity. The approach has resonated with some advisers. But for those who still struggle with what role it plays in a portfolio, there are a few things they should know.
This insider-sentiment strategy, which is available in only a handful of vehicles on the market, involves tracking “smart money” by watching what insiders are buying to gain insights into what stocks are most likely to perform well.
The idea is first to use a filtering process to eliminate stocks of companies with overly aggressive accounting practices; then examine other factors, such as the number of insiders buying company stocks on the open market or increases in analysts' expectations.
AFFORDS GREATER EXPOSURE
It is a strategy that has been successfully employed by institutional investors for years and now affords the average retail investor much greater exposure to decisions of key shareholders. Unlike other strategies in this space, it is not complex and runs little risk of deterring investors who shun products they don't understand.
Sophisticated portfolio builders can determine how much excess return they can handle and carefully balance the strategy alongside other strategic-beta investments that address volatility reduction and income generation.
An insider-sentiment strategy with fewer constraints on the amounts that need to be allocated to certain sectors will have the flexibility to overweight sectors when necessary. And some products feature a defensive overlay that can help mitigate downside risk in volatile markets by using a heavier weighting on stocks that have performed well during periods of distress.
MOMENTUM WILL CONTINUE
Strategic-beta ETFs have transformed our approach to investing and no doubt their momentum will continue. With this evolution, advisers will need to work a little harder to sift through the endless choices to find strategies that fill the critical gap in their clients' portfolios.
For some investors searching for excess return, smart money may be just the exposure they need. With it, those looking to outperform the market can react to the decisions of informed participants, relying on some of the smartest minds in the industry.
Andy O'Rourke is managing director and chief marketing officer at Direxion.
