'Active' By Another Name

July 01, 2018

[This article appears in our July 2018 issue of ETF Report.]

Smart-beta strategies are one of the hottest investment trends in exchange-traded funds; ETF.com estimates there are nearly 1,000 of these funds.

Using the term “smart beta” as a catchall for strategies like fundamental indexing or factor-based investing, these strategies are rules-based, and aim to deliver better risk-adjusted returns than traditional market-cap-weighted indexes. Some people in the ETF industry say smart-beta strategies have the benefits of active management, but have the low costs associated with indexing.

Yet is it correct to assume smart-beta strategies are simply active management by another name?

The answer is, it depends.

Quantitative Gray Area
When it comes to quantitative active management strategies, Elisabeth Kashner, CFA, director of ETF research at FactSet, says it’s difficult to know for certain if smart beta and active management strategies are similar.

“The reason I say that is that there’s a lot of proprietary information that goes into quantitative hedge funds and mutual funds.” she said. “Active managers have every reason to keep their models a secret. They don’t want to share their proprietary model.  After all, their goal is to outperform everybody else’s proprietary model … [but] it does seem extremely likely that the same methods are used.”

Todd Rosenbluth, director of ETF research for CFRA, says most smart-beta strategies are based on long-standing quantitative research or based on recently developed academic information. Among the differences between quantitative active management and some smart-beta ETFs are that ETFs are transparent with their rule book, are more tax efficient and are lower cost than mutual funds.

For Eric Balchunas, senior ETF analyst at Bloomberg Intelligence, trying to draw a distinction between active management and smart beta may be splitting hairs: “All smart beta is active.”

Yes, smart-beta strategies involve indexing, rebalancing on a schedule and are devoid of human interaction, which makes them passive in a way. Still, he says smart beta is active. Whether the ETFs are called “smart beta” or “active,” in the end, they have the same purpose: something that deviates from a market-cap-weighted index, he says.

Part of this debate between smart beta and active management may be occurring because there’s been a deviation from the original Towers Watson definition of smart beta, Balchunas says, which was that it was a better way to package and deliver active management.

“It’s a third of the costs of a true active mutual fund; there’s no emotion whatsoever; and it’s got better tax efficiency. If you go right back to that original definition, that is still true [about smart beta],” Balchunas said. “What’s happened is, over the years … people are using the word ‘smart’ to make it seem like it’s going to outperform, and that may or may not be true … I think a great way to look at smart beta is it’s active [management] in smarter packaging.”

Active Difference
Janet Johnston, portfolio manager at TrimTabs Asset Management, which has two ETFs that combine quantitative analysis and active management, the TrimTabs All Cap U.S. Free-Cash-Flow ETF (TTAC) and the TrimTabs All Cap International Free-Cash-Flow ETF (TTAI), disagree that smart beta and active management are the same.

 

 

“First of all, smart beta isn’t smart and it isn’t active. It’s marketing that has worked very well for those products in terms of raising assets, but it’s fake news,” Johnston said. “The investor has to be the smart one.”

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