Investments

June 9, 2017 / Craig Eppler

What is Smart Beta?

If you have opened a Bloomberg magazine, read a Financial Times article, or turned on CNBC, chances are you have come across Wall Street’s newest invention: smart beta. Smart beta has quickly become one of the fastest-growing segments in the financial industry, and is a pervasive theme in investment management. Smart beta assets have doubled since 2012 and now exceed $500 billion. But what is smart beta and how does it affect your portfolio?

Smart beta may seem new and foreign, but the fundamental concept behind it — factor investing — dates back to the 1960s. Factor investing seeks to identify and capture broad, persistent drivers of return, which, generally speaking, are inexpensive companies with high-quality balance sheets. Once factors are chosen, the aim is to turn these investment factors into cheap tracker funds or exchange-traded funds. Following are a few of the common factors portfolio managers use when constructing their smart beta strategies and their objectives when employing the given factor.

Factor Objective
Value Cheap stocks outperform
Size Small stocks outperform large
Low-Risk Lower beta, less volatile stocks outperform
Momentum Winners continue to win and losers continue to lose
Income Higher-income stocks will have higher returns

 

These smart beta factors allow portfolio managers to craft an index based on well-understood drivers of return. In contrast, a traditional passive index fund follows more rigid guidelines to track market cap- weighted indexes. The goal of smart beta is to improve portfolio outcomes and reduce portfolio costs with products that have lower average expense ratios than traditional active managers tend to possess.

At this point, you may be wondering what all of this means for your portfolio and how the team at Hoover Financial Advisors is utilizing this new investment tool. In short, there are funds across our approved fund list that use similar smart beta / factor-based investment methodology in areas that our methodology demonstrably deems best value for your portfolio.

Dimensional Fund Advisors have a significant number of funds on our fund list that employ strategies similar to those discussed above. Dimensional takes a less subjective and more systematic approach to investing, relying heavily on its research team to interpret market data. The firm offers strategies that seek to beat the market by targeting exposures to what it views as the types of risks that the market rewards. These are characteristics that historically have been associated with higher expected returns, such as value, small market capitalization, and profitability. Additionally, Dimensional’s low turnover, structured trading strategy is another element of its secret sauce, which has allowed 82% of  its funds to outperform the company’s respective benchmark over the past 15 years. 

You may notice American Beacon Bridgeway Large Cap Value Fund in your portfolio. This is another fund in our lineup that uses a similar strategy to smart beta. Bridgeway offers evidence-based, statistically driven criteria in its investment processes that seek a quality tilt in its stocks, for participation in up markets and risk mitigation in down markets. The similarity to smart beta in this fund comes from the statistically driven investment strategy and multi-factor models. The process involves seeking stocks with primary factors of proper value metrics, price momentum, and strong financial health. Intended to outperform the Russel 1000 Value Index, Bridgeway’s factors also review for diversification and tax impacts.

Let’s return to the initial question: What is smart beta and how does it affect my portfolio?

  • Smart beta is a statically based, factor-driven investment strategy that seeks inexpensive, high- quality companies.
  • These funds provide an alternative to passive index investing and pursue superior risk-adjusted performance.
  • Your portfolio has used funds with similar factor-based strategies to provide alpha in efficient markets.

In a nutshell, smart beta is about taking risks where we expect to be compensated for it.

If you want to learn more about this topic, please don’t hesitate to contact our office. We’re happy to answer your questions or provide more detail.

Sources:

Morningstar
Dimensional Fund Advisors
American Beacon

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