Due Diligence Critical As Smart Beta Grows

June 07, 2016

Have we reached a plateau of innovation in smart beta?

Clare: Quite a lot of so-called new ideas are just variations on the same theme. There is a limited number of smart-beta approaches that work, and it’s just a question of how fund managers and index providers package them and market them. Having said that, I wouldn’t be surprised to see more innovation over the next year or so.

What is the most common myth you need to debunk regarding smart beta?

Clare: I’m not sure I would call this a common misconception, but I would point to the general ignorance—if I can call it that—of smart beta. There is so much out there, and it’s so difficult to know what is on offer and why. It’s knowing how to analyse these strategies and products and how to select them in the first place.

Vanguard launched a four-strong smart-beta ETF suite in December, with annual fees as low as 0.22%. Will that move set a trend for lower smart-beta ETF costs?

Clare: Yes, I think so. It’s generally difficult to justify charging active fees, or fees that are closer to active, for a rules-based, computer-based approach to investing. I definitely think there is and will continue to be a trend for lower costs.

Can you make a smart-beta ETF portfolio work by picking individual risk-factor ETFs?

Clare: It depends how the factors are combined. If there is any sense of a discretionary manager in the process, that could be a problem, but if it’s a rules-based approach, then the strategy has potential for getting the best out of a number of smart-beta approaches.

But what about multifactor ETFs, which combine, say, value and momentum within one index?

Clare: I would need to see the evidence for that. I was referring more to picking smart-beta ETFs and rotating between them.

Do you have any advice on how an adviser could dip their toes into this market?

Clare: Read papers one and two of ours, at least, or papers from another independent source, because that starts you off with the basics. 

But should smart beta only be a small part of your portfolio? Not necessarily. Talking about equity investing, I don’t see any reason smart beta couldn’t make up 100% of your allocation.

Is this the end for market cap?

Clare: No. Market cap will always be there, as it’s so convenient, and really, in terms of scale, there’s no limit to how much money can be allocated that way.

What about smart beta in fixed income?

Clare: It’s in the very early stages. Equity smart-beta investing has been around now for about 10 or 12 years. In fixed income, it’s much more difficult to establish similar approaches to investing, mainly because liquidity is more problematic. Maybe in 10 years’ time, fixed-income smart-beta approaches will be where equity smart-beta approaches are today.

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