Smart Beta: The Proof Will Be In The Pudding

Industry experts agree the phenomenon will grow but it will take time and will not be suitable for all investors

Editor, Europe
Reviewed by: Rachael Revesz
Edited by: Rachael Revesz

The proof will be in the pudding for the success and growth of smart beta, industry experts agreed today, as the investing phenomenon will take time to gain more traction, but it might not be suitable for all investors.

Smart Beta Looks Active

Speaking at the ETF Portfolio Summit at the London Stock Exchange, Thomas Merz, head of UBS ETF sales for Europe, said that he thinks smart beta – non-market cap strategies – are moving to look more like active management rather than the other way around.

“It used to be a swing from active to passive and now it’s a bit of a rebound,” he said.

UBS manages around $50 billion of alternative beta, but Merz said it makes up a small proportion of the firm’s overall passive business. Merz insisted that he had not seen clients using smart beta for their so-called “core allocations” and would sometimes recommend the market cap approach for clients if it’s “safer”.

However, James Waterworth, vice president in UK and Ireland institutional ETF sales at Lyxor Asset Management, said there are big institutional clients like Dutch pension fund PGGM and Scottish Widows Investment Partners in the UK who put over £2 billion into alternative Research Affiliates strategies at the heart of their portfolios.

What Does It All Mean?

Waterworth said investors must first ask themselves what they want to achieve, then look at the index strategy.

“If you like value, what does it mean? Is it a distressed stock, when BP is leaking oil into the gulf? Or is it a more robust, boring stock that doesn’t have the sexiness of a tech stock and just pays a sustainable dividend?” he said.

Merz lamented that clients using market cap strategies are not carrying out the same analysis and due diligence as with smart beta funds.

“On smart beta, that’s where I say to a client: “Yes you must understand the index”,” he said. “This should happen on the other side as well but everyone assumes they know how the FTSE 100 works. I have the feeling that not everyone who buys it fully understands it.”


Back-Tested Data Concerns

Another concern of smart beta for Merz was the back-tested data, which makes up the majority of the performance data available, while the live track record might be just two or three years.

“Just be careful of reading too much into 40 years of back-tested data as behaviour can [change],” he said. “The problem is how do you model it for forward-looking [returns]?”

Bryon Lake, head of Invesco PowerShares for Europe, the Middle East and Africa, pointed out that not all factors will perform at the same time. In fact, investors might be wiser to choose a strategy with negative past returns if they are preparing to exit the seven year bull market in the U.S., for example.

“Momentum has been fantastic for last five years, but will that continue for next five years?” he said.

A Recipe For Success

When questioned on the future growth and usage of smart beta ETFs, Waterworth chose the analogy of ordering a lasagne in a restaurant.

“You’ve got pasta, meat, and ragu – but you’re also buying carbohydrates, proteins and fats – it’s a change of mind-set – you’ve got the same thing but it’s just a case of thinking about it in a different way,” he mused.

Merz then quipped that in the future, investors will choose between ready-made smart beta products – “lasagne al forno” – and the individual, building block funds.

Rachael Revesz joined in August 2013 as staff writer. Previously an investment reporter at Citywire, she has a background in writing content for retail financial advisors and has covered a wide range of subjects in finance. Revesz studied journalism at PMA Media, which has since merged with the Press Association. She also holds a B.A. in modern languages from Durham University, as well as CF1 and CF2 financial planning certificates from the CII.