Deconstructing Smart Beta

February 10, 2015


Case Study
To demonstrate the potential benefits of using alternate beta strategies as building blocks in portfolios, we constructed a hypothetical portfolio with a 40 percent allocation in low volatility equities with the aim of reducing risk, and 60 percent equally spread across small cap, value, momentum, and quality indexes in order to enhance return. Similarly, we created an alternate commodity beta portfolio with 40 percent weight in the S&P GSCI Risk Weight index, which is an index based on equal risk contribution from five commodity sectors, and 60 percent weight equally spread across curve, value and momentum. All the building blocks here are represented by long-only equity and commodity indexes.
Implementation Issues to Consider
Overall, the development of alternate beta expands the repertoire of possibilities for a portfolio. This is especially true in North America and Europe, where the diversity of investment styles and strategies can be accessed through ETFs, funds, swaps and segregated mandates in a transparent and inexpensive way.
For institutional investors, the process of investing in alternate beta requires setting investment objectives, establishing target factors, selecting index strategies and managers to carry out the implementation, and finally constructing the portfolio while measuring and monitoring performance on an ongoing basis (Exhibit 4). This involves certain challenges.
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