[Editor's Note: We are rerunning some of our best stories of the year.]
This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Andrew Gogerty, vice president of investment strategies at Boston-based Newfound Research LLC.
Lockheed Martin’s Advanced Development Programs, famously known as Skunk Works, is a think tank for cutting-edge aircraft design. It is noted for the high degree of autonomy given to its engineers.
Despite a focus on innovation, the team adheres to “KISS,” an acronym for “Keep it simple, stupid.” The general philosophy of KISS has been observed in many industries. Albert Einstein once said, “It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience.”
This quote is often paraphrased as “Everything should be made as simple as possible, but no simpler.”
As demand for factor, or “smart beta,” exposure has increased, so has the complexity and number of smart-beta ETF offerings. There are now not only a plethora of single-factor options, but ETFs that look to combine multiple factors into a single portfolio.
As the number of alternatives becomes overwhelming, it can be tempting to turn to “throwing spaghetti at the wall to see what sticks” method of portfolio construction. Instead, we recommend that investors use KISS, which is at its core is an efficiency philosophy.
The “stupid” doesn’t refer to intellect; rather, the ability to use simple tools and steps to address even the most complex problems. Building a smart-beta or factor portfolio, means sticking to tools and exposures that are thoughtfully simple in their philosophy and implementation.
It also—and perhaps most importantly—means being able to identify where past risk-adjusted outperformance has come from and to articulate why this outperformance is likely to continue.
In a previous article, we outlined steps for selecting a smart-beta ETF. Our focus here is on building a comprehensive smart-beta portfolio. Newfound’s U.S. Factor Defensive Equity Strategy uses five smart-beta ETF exposures. But general ETF selection is still built around three core ideas:
- Simplicity in process
- Consistent backing with academic literature
- Relatively pure in exposure
Our portfolio includes exposures to value, momentum, low volatility, size, and dividend growth. Below are some of our thoughts and considerations that went into selecting the ETFs for this strategy’s investment universe.