The smart-beta ETF industry has long been centered on asset growth and new, innovative products, from single-factor to multifactor and beyond.
But do investors really understand how these products work? And most crucially, how can investors compare products and evaluate performance?
Melissa Brown, senior director of applied research at risk management and portfolio construction firm Axioma, says the new wave of smart-beta evolution will be focused on comparing smart-beta performance to a benchmark, just as investors are used to doing with other funds.
Investors can catch Brown’s keynote speech on the future of smart beta at the Inside Smart Beta conference in New York on Sept. 22 and 23.
There is a true plethora of smart-beta and risk-factor ETFs on the market now. That fact alone must make it difficult to know how to pick the right product.
Brown: You have various types of smart-beta portfolios that sound very similar but are in fact very different, or you have portfolios that sound very different but are very similar.
For example, if you take two high-dividend-yield ETFs, the names may say “dividend yield,” but they will have very different sector weightings, different names and concentration of those names, etc. And if you compare a group of high-dividend-yield ETFs to a group of low-volatility ETFs, they’re actually very similar [in their makeup], apart from the dividend yield.
The bottom line is you really need some kind of benchmark—not the one the ETF provider creates for the fund to target, but a broader, more generic benchmark for the market you want to track. It’s not about saying what’s right and wrong, but the benchmark will help inform you of the differences in ETFs’ performance.
So even comparing a U.S. equity risk-factor ETF to the S&P 500 could be helpful?
Brown: Yes, but you’re not looking for a generic market benchmark; it’s one that somehow reflects what your ETF is trying to achieve.
We propose the future of smart beta will be about evaluating performance, rather than discovering new products and factors. I don’t know how many “new things” are out there to exploit anymore. In terms of factor ETFs, maybe a provider can find some niche industry and create an ETF there, but that’s not where the assets are going to come from.
How do investors take that first easy step to evaluate performance?
Brown: I don’t think there’s an easy step to doing it. Somebody will have to create those benchmarks, deciding what defines them and then creating them. That’s not something you can do tomorrow.
My presentation [at the Inside Smart Beta conference] focuses on a few ETFs through the lens of a risk model so you can get a sense of how they’re similar and different, but we don’t suggest which benchmark you use.