Index explosion
As Bloomberg reported in May, there are now more indices than securities in the US. “Now you’re becoming an index picker rather than a stock picker,” Poullaouec said.
This ever growing variety allows investors to implement a range of particular investment views, just by picking an ETF.
One of the newest trends has been merging the smart beta approach with ESG. The SPDR SSGA Gender Diversity Index ETF, launched in March 2016 and listed as “SHE” on New York Stock Exchange is an example of such a product. It implements a belief that companies with more gender-balanced leadership perform better.
As new indices are created daily, providers are striving to make them “purer”. This means shedding the constraints that some indices – such as low volatility – have on how much they can depart from the original market capped index.
“That is a good start, but it is not a pure exposure to the minimum volatility factor,” said Poullaouec. “As the investors become asset and factor allocators, they need purer exposure to factors they really believe in.”
Multi-factor products
Smart beta typically focuses on one factor. A type of smart beta − the multi-factor product − is designed to provide diversified exposure to several factors.
“Different factors will react differently in the investment cycle,” said Poullaouec. “You want to have diversification to benefit from value being very weakly correlated to low volatility or quality.”
Different factors tend to perform differently during the market cycle, but timing the factors “is not the right answer for investors,” he said. The main value of the multi-factor approach is to have a broadly-diversified portfolio.
Nevertheless, overweighting certain factors at the right time can be beneficial. Notably, the value factor underperformed low volatility and quality before mid-2016, according to Poullaouec, but that changed in the second half of the year.
“That was a signal that the underlying economy and business confidence was changing,” he said.
“The value style is typically in favour in an early acceleration of the economy.” Although the trend has reversed in 2017, “we are still overweight value and underweight low volatility because we think that this is a trend that will continue to persist in [2018].”
An old concept
Smart beta investing principles have been known for decades.
“Research in the 1970s and 80s showed that value, size and other factors can explain the alpha of managers, but only recently the industry packaged this type of research into products,” Poullaouec said.
By one definition, any index-based product that strays from market capitalisation weighting can be called smart beta.
For example, the ABF Pan Asia Bond Index Fund (an ETF), listed in Hong Kong since 2005, adjusts bond weights away from issuance size in order to focus on those with higher liquidity and to reduce the outsized allocation to Chinese bonds.
“That was a smart beta product without being called by that name. Today it would be classified as smart beta,” said Poullaouec.
