Smart Beta Comes Full Circle

May 22, 2019

[This article appears in our June 2019 issue of ETF Report.]

Smart beta strategies are evolving, and newer ETFs from Vanguard and BlackRock appear to blur the lines of what were strictly passive vehicles.

Originally, smart beta strategies sat between plain vanilla, market-cap-weighted indexes and actively managed funds, taking the rules-based approach of indexes and adding a filter to tilt the strategy to express a factor, such as quality or size.

But with the newer factor-based quantitatively managed active ETFs, smart beta may be morphing into something a bit different.

Another Look
Vanguard’s suite of six actively managed factor ETFs debuted in February 2018, with the Vanguard U.S. Multifactor ETF (VFMF) having the largest assets under management (AUM) at $86 million. The funds are actively managed, but the portfolio manager follows a rules-based process to select and weight the securities. The portfolio manager rebalances the fund as they see fit to conform to the factor.

The BlackRock U.S. Equity Factor Rotation ETF (DYNF) launched in March. It’s an actively managed fund that uses momentum, quality, value, size and minimum volatility to select stocks, and also will emphasize which factor might do better based on manager discretion using four economic and technical indicators.

Ben Johnson, director of ETF research at Morningstar, considers these actively managed ETFs “a natural evolution” in terms of smart beta product development.

Matthew Jiannino, head of quantitative equity product management at Vanguard, says the innovation with its ETFs is to get advisors from thinking about style boxes for portfolio construction to using factors instead, and to give advisors risk models and tools so they can get as much targeted factor exposure as they want.

“To us, that’s when it—not the smart-beta world, but the factor world—really starts to take off, because now investors can use factors … in existing portfolios,” he said.

Andrew Ang, head of factor investing strategies for BlackRock, calls DYNF the “absolute future of factor investing, which is to put more active insight into all of our investments.”

Just as hedge funds and other institutional traders use factors to time investments based on economic or technical chart signals, BlackRock seeks to do the same with DYNF.

“This is the best embodiment of being active with factors,” Ang explained. “It packages active management and insights, and delivers it through an ETF. It’s an entirely active approach, and that’s why it’s new.”

Next Frontier?
Both Morningstar’s Johnson and Chuck Self, chief investment officer at iSectors, say the Vanguard products contain the DNA of what firms like Dimensional Fund Advisors created with their factor research, and both say they aren’t sure if those ETFs are really making significant leaps into new territory.

“They’re a close cousin to what some asset managers label a ‘systematic active equity’ strategy,” Johnson said. “It’s an approach to portfolio construction that’s been supplied by firms like Dimensional Fund Advisors or AQR for decades.”

Jiannino says Vanguard’s approach goes back to the firm’s active management approach: “We’re using a lot of the similar signals based on academic research. A lot of them are well- known, but we said if we would build our own factor products, how would we do it, and a lot would be tied back to us as active managers.”

 

 

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