How To Evaluate Smart Beta ETFs

June 02, 2017

It’s hard to keep track of all the smart-beta ETFs hitting the market these days. But according to OppenheimerFunds’ David Mazza, there’s a repeatable process to follow in evaluating those funds.

In a conversation with Inside ETFs CEO Matt Hougan, Mazza, who is head of beta solutions investment marketing and ETF specialists at OppenheimerFunds, discusses his ETF due diligence policy, and examines whether today’s smart-beta strategies are getting “crowded.” Mazza is a featured speaker at the forthcoming Inside Smart Beta conference, taking place June 8-9 in New York City, where he’ll be digging into this topic at a deeper level.

Matt Hougan: All smart-beta products promise great returns. But one thing we’ve found is that the live results don’t always measure up to the backtests. Why is that? And should we worry about an “observation effect” ruining factor investing?

David Mazza: Investors really need to understand where smart beta fits in their portfolios and then use that realization to evaluate funds and answer those questions appropriately.

Smart beta has the potential to do three things for investors: It can offer the potential for increased returns, reduced risk or improved diversification. You have to understand your desired investment outcome before you evaluate a fund and its performance.

A low-volatility product may get beaten up in certain time periods; there may even be times when it has higher volatility than the market. But in the very long run—10 years, or more—it may offer a smoother ride. Viewed through that lens, I might accept some underperformance in the short term.;

The industry throws out the buzz term “outcome-oriented investing” quite a bit, but it’s actually quite relevant vis-a-vis smart beta. You have to understand the long-term return that you’re going for and hold these products accordingly.

Hougan: How do you make sure investors stick around for those long-term benefits?

Mazza: That’s the big question, and the answer is, you need truth in labeling and a real focus on education from ETF issuers, index providers and the financial industry at large.

ETFs are a disruptive technology, and smart beta is at the forefront of that disruption in terms of its impact on both the cap-weighted community and the active side. Fortunately, we are now moving beyond finger-pointing and are dug in on true due diligence around how to best use these products.

When I’m speaking with investors and looking to position either existing funds or new solutions in their portfolios, I’m going to focus most on why the underlying anomalies that drive factor returns exist, and highlight the outcomes that they deliver. That’s what will help them hold portfolios long enough to realize the benefits smart-beta strategies may deliver.


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