Toroso's Venuto: Pick Smart-Beta ETFs Wisely

April 14, 2014

Toroso Investment’s Mike Venuto says smart-beta ETFs are great tools, but it all hinges on the market environment.

Smart-beta ETFs may be all the rage, but they don’t make sense in every market environment, says Mike Venuto, chief investment officer at Toroso Investments, a New York-based advisory firm.

Arguing that the marketing spin surrounding these strategies can prevent investors from truly grasping how smart-beta funds can fit in a portfolio, Venuto warns that understanding the current macroeconomic environment is the key to using these strategies smartly.

Venuto, who was previously head of investments for Global X, now designs core asset allocation and fixed-income strategies for private wealth as well as institutional clients at Toroso. The Toroso CIO, who helped launch a multi-class mutual fund that comprises only ETFs, also stressed that smart-beta-type products are much needed in the fixed-income space. Do you use smart-beta ETFs in your mutual fund?

Mike Venuto: Absolutely. We think there’s great value in what’s been classified as smart-beta ETFs. But we recently wrote a paper about smart beta because it is our understanding that everyone seems to define smart beta as anything other than traditional market-cap-weighted indexes. We felt that that’s too broad of a definition.

We agree that everything other than market-cap-weighted are nontraditional indexes, but we need to better define what subcategory of that we call smart beta.

We see it as indexes that have beta—that are focused on a traditional exposure but use something like fundamentals or dividends, or anything in that space, to reweight the index. We would put equal-weight, characteristic-based, risk-parity-based and fundamentally weighted all under nontraditional indexes, and only the latter would we call smart beta. So, you define smart beta solely as fundamentally weighted ETFs. What do you see as their biggest appeal? Are they good for downside protection or to capture outperformance, or both?

Venuto: That’s an excellent question. They can be good for downside protection, or for generating alpha, but the portfolio manager’s job is to figure out what the current macroeconomic environment is, and which fundamentals should do well in that environment. These ETFs are valuable for both protection and enhancement, but it depends on the market.

Last year, for example, it didn’t matter that much. The stock market rallied 30 percent. But in a year when the market is moving sideways or down, fundamentals can matter a lot. The example that we would use is RevenueShares’ revenue-weighted indexes.

In today’s macroeconomic environment, one of the key aspects is that margins are stretched. Current net margins of the S&P 500 Index are more than 10 percent. The historical norm is around 5 percent. When we look at that, we think about the small-cap universe.

We think that what are likely to be acquisition targets are companies with good revenue and small net margins, because when they are acquired, the acquiring company can bring up those net margins.


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