Are Smart Beta ETFs Actually Smarter?

When it comes to new ETFs entering the Canadian market place, Smart Beta strategies are continuing to offer some buzz to the industry. According to National Bank’s ETF Research desk, $745B has been invested in Smart Beta strategies in the US and $14.6B in Canada, representing 21% in total US assets and 9% for Canada! With so many different types of Smart Beta products, it’s important that investors understand how they work and what outcomes these products are trying to achieve.

So what is Smart Beta trying to accomplish? Well its main goal is to provide the investor with an overall better risk-adjusted return. To do this, an investment management team would create a custom index that is designed to outperform the traditional cap-weighted indices that are often used as a benchmark.

This is similar to what an active manager is trying to accomplish. I like to describe Smart Beta as a quasi-active strategy, since there is a human element to get the rules and screens figured out, but once the strategy is implemented, it is essentially then run passively.

So how do I know which Smart Beta strategy to buy? As the number of products and providers offering these types of strategies continue to increase, the search for the right offering can be overwhelming. Due diligence is a must. It is very important to check under the hood and un-wrap the nuts and bolts, so to speak.

As with most types of investment products, I find simplicity is the key. If the methodology is too complicated then you are going to have a harder time understanding it, let alone explaining it to your clients. For the average investor, a smoother ride over the long term could be an appealing option when it comes to Smart Beta strategies. These types of strategies tend to provide a lower overall portfolio beta, which over the short and long term, is an easier ride for investors to stomach.

A multi-factor Smart Beta strategy that pairs factor such as quality, value, momentum, and low volatility  have historically provided a smoother ride with less volatility. Don’t underestimate the value that a smoother ride provides. One of the biggest risks investors face is their own reactionary behaviour and lack of discipline.

Over past few months there have been some notable examples where we have seen this happen. Big companies have seen huge selloffs for a variety of reasons:

• Facebook set a record with its single day market cap loss of $150 Million USD after revising revenue expectations during a quarterly call.
• Twitter shares dropped 20% after announcing they had lost one million users as they purged fake accounts from their network
• Tesla stock experienced a dramatic 9% plunge in after its CEO was in the headlines following controversial tweets and interviews.
• Netflix stock was reeling after missing expectations on subscriber growth last quarter.

Markets are driven by emotions and can result in wild swings, but a smoother ride provided by the right type of Smart Beta strategy can help investors fight their own worst enemies: themselves.