Behind Smart Beta ETF Dispersion

February 12, 2018

What 2017 Teaches Us About Smart-Beta ETF Dispersion

Over time, the differences associated with sector neutralization should wash out, as one would expect the underlying factor variance to explain most of the overall ETF variance. However, 2017 highlights how wide and lopsided sector dispersion can lead to smart-beta ETF dispersion.

So, what is the right approach when constructing smart-beta ETFs?

If you look under the hood of most tactical sector rotation strategies, they’re generally incorporating some form of momentum or trend-following signals. Rarely will you see them incorporate valuation-based signals. That is because momentum, rather than valuation, tends to be a better predictor of forward relative returns.

Factor purists would argue that one should invest in the factor itself, regardless of the resulting sector or ancillary risk exposures. You take the bad with the good, because it all helps explain the historical factor behavior. It’s when you start introducing neutralization and optimization techniques to stamp out the “unwanted” external factor sources that you lose the purity of the underlying factor.

Regardless, the sector dispersion of 2017 highlights the importance of knowing what you’re investing in.

Sector neutralization might make sense if you hold a portfolio with few positions and you desire the underlying sector exposures to reflect the broader market. Non-neutralization might make sense if you are targeting purer factor exposures, or if you want to offset the sector bets taken in other parts of the portfolio. It comes down to portfolio construction and how the smart-beta ETF fits within your overall portfolio.

At the time of this writing, 3D Asset Management held positions in USMV, SPLV, VTV, and MTUM. The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate; however, 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above is all inclusive or complete. Past performance is no guarantee of future results. None of the services offered by 3D Asset Management are insured by the FDIC, and the reader is reminded that all investments contain risk. The opinions offered above are as of Feb. 6, 2018, and are subject to change as influencing factors change. More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm’s Form ADV Part 2, which is available upon request by calling (860) 291-1998, option 2, or emailing [email protected] or visiting 3D’s website at

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