How To Tell If A Smart Beta Trade Is Crowded

May 23, 2017

With smart beta and factor strategies growing in popularity, getting in and out of them has become a real concern for today's investors. Are they getting too crowded? How long is too long to be in a strategy? Can I bet against these factors and make money?

Deepika Sharma, portfolio manager and managing director of investments at Astor Investment Management, has done the research and knows what it will take for investors to have success using smart-beta and factor-based ETFs.

Ahead of our Inside Smart Beta conference in New York City on June 8 and 9, Sharma explains why looking at the economic cycle is vital to smart-beta investing and why we still have a long way to go before we reach capacity in these innovative strategies.

Inside ETFs: Would you walk us through a little bit of Astor’s approach to asset management and your firm’s thoughts on smart-beta or factor investing? Sharma: Absolutely. At Astor, we believe in the predictive ability of economic fundamentals. We call it the Astor Economic Index, which we use for asset allocation.

The Astor Economic Index aggregates trends in economic fundamental data, looking at coincident and leading indicators to determine where the economy is now, and where it is headed. We put the biggest loading into the macro factor or the business cycle risk factor to determine our ratio of stocks and bonds, and how to direct asset allocation for the next six to nine months.

Inside ETFs: Does Astor distinguish between factors and smart beta?

Sharma: The way that most investors understand smart beta is that it’s a “new” way to invest in equity markets. We disagree, which is why we often use the term “factors” rather than “smart beta.”

When we say “factors,” we cover broad and persistent drivers of performance across asset classes that have been used by active managers for decades. These factors—value, carry, momentum, volatility, etc.—work in other asset classes like fixed income, currencies and commodities as well, and often overlap with smart-beta strategies.

The perception of what smart beta is will change as there is more information and more products that are looking at factors or smart-beta strategies outside of equity markets.  

Inside ETFs: When we talk about smart-beta factors, they’re typically long-term solutions. Astor employs a tactical approach to investing. How do the two approaches work together?

Sharma: We try to look at factors using the same principles we use for asset allocation, which is an economic regime and risk perspective.

We implement that perspective though the Astor Economic Index, and we would rather use the dynamic rather than a tactical trading approach; that is, we can change exposure when economic conditions warrant, not just for the sake of trading. And we can apply the same philosophy of not timing stocks to avoid timing factors.

And by “timing,” I mean making short-term shifts on a month-to-month basis. So you're not going from 100% value to 100% momentum strategy in a month or a quarter. What we’ve found is that people who try to do that, and those who try to chase performance and buy popular factors, usually end up getting burned by that kind of strategy.

We’ve come to the conclusion that, just as timing stocks doesn't significantly impact your bottom line if you're a long-term investor—asset allocation does—timing factors will not either, and will just add to your transaction costs.

So, it's better to tilt than time. We tilt by overweighting or underweighting a certain factor depending on whether we’re in a growing economy or we observe signs of weakness, whether or not investors have a high-risk appetite, etc.

 

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