Smart beta exchange-traded funds (ETFs) are designed to provide focused exposure to one particular factor such as quality, value or low-volatility by weighting the index components differently than market capitalisation, as most standard indices do.
They are managed automatically without ongoing human intervention. The indices, however, are highly customised.
The allocation to individual stocks within a smart beta ETF strays from market capitalisation in order to overweight a particular factor.
In providing such exposure, smart beta ETFs act as active investments, argues Poullaouec, head of strategy and research for the SSGA investment solutions group. In particular because they implement a view on the market.
Using smart beta products requires the investor to switch focus from selecting a manager to asset and factor allocation, he noted. “That is a really different skill set.”
Smart beta adoption
“Smart beta is a challenge to the active [approach], because if your active manager is not able to outperform smart beta, why pay active management fees?”
However, the reality is that smart beta products will likely coexist with active managers and passive funds, Poullaouec said.
While they can replace, at a lower cost, some active funds that provide pure exposure to investment factors, the do leave room for active managers who offer a truly differentiated style.
In a multi-factor portfolio, smart beta products can provide complementary exposure to factors underweighted in the active funds already held in the portfolio, Poullaouec said.
Individual investors are not the natural adopters of smart beta products. As each product reflects a view on the market, choosing them requires expertise in both asset allocation and factor allocation.
Factor investing requires looking at portfolio construction in a new way. Poullaouec describes the process using coordinates: “On the horizontal axis you can see the asset allocation and on the vertical you can see factor allocation.”
Factors, which can be interpreted as risks, often span across asset classes. For example, credit risk in the fixed income sleeve of the portfolio is aligned with equity risk in the portfolio.
