Smart beta’s selling point seems to be that it sits somewhere between active and passive funds.
Mr Midgen explains: “Smart beta is a bit of a halfway house between pure passive, where the objective is to reflect the broad market returns, and pure active where, through stock selection or market timing or research, a manager identifies investment opportunities. Smart beta sits in the middle.
“For example, one of the drivers of the growth of value smart beta strategies is investors thinking, ‘if I believe in value as a systematic source of return, I can pay an active manager, or I could implement my strategy through a rules-based approach that may capture what the active manager may achieve for me anyway, but at a lower cost’.”
Howie Li, head of Canvas at ETF Securities, agrees smart beta products are seen as a “bridge” between passive and active investing.
But, he cautions: “Like an active fund, smart beta products are designed to add value. However, while it empowers the investor to seek something in addition to market exposure – beta – at a lower cost, it is important for investors to understand which tools should be used to match their desired investment outcome.
| Definition of smart beta |
In a report published by Source in November 2015 called ‘Being smarter about “smart beta”’, author Chris Mellor, head of equity product management, asks what’s in a name? The term “smart beta” is now widely used but is not universally accepted. There are many other terms that refer to roughly the same category of investment products, including strategic beta, non-traditional indices, advanced beta, enhanced beta, beta plus, engineered beta, and second generation indices. How other providers and firms define smart beta: • Between alpha and beta (Towers Watson) • The middle of the passive-to-active spectrum (Morningstar) • Investment strategies based on one or more of the five equity factors (SSgA) • Indices that are not weighted by market capitalisation (Russell Investments) Source: Being smarter about ‘smart beta’, by Source |
“There is no ‘one size fits all’ product and the purpose for each smart beta product can vary greatly from minimising volatility of a passive investment, to tracking momentum or improving risk-adjusted returns. With the proliferation of smart beta products coming to market, an understanding of their uses, as well as timing, is paramount.”
If an investor is comfortable with how smart beta works then there are an array of products offering exposure to different factors, whether that’s value investing, momentum or small-cap stocks.
Smart beta also highlights some of the limitations of passive or index funds, as Mr Mellor acknowledges. “The best example of that is the tech sector, which made up more than a quarter of the S&P 500 [index] in 1999 and we all know how well an investment in the tech sector went in 2000-02 as the bubble burst.
