An Investment Strategy that’s Hidden in Plain Sight

 

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Black Friday might be behind us, but I’m still hunting for bargains this holiday season. This year I’m determined to be tempted only by the sales on the things I actually want andneed. Too often I’m tempted by a bargain that turns out to be, well, a dud.

The challenge for investors is much the same. We’ve all become more fee conscious in recent years, and are often seeking more for less,  but just may end up getting… less. If you think there’s got to be a better way, you’re right.

I’m talking about smart beta, which can offer a similar risk and return profile to certain traditional active strategies at a lower cost. As I discussed in my last post, smart beta strategies seek to enhance risk-adjusted returns through  exposures to desirable factors or themes – much as traditional active strategies do —  but delivered  in a transparent and rules-based way, like passive strategies.

So where might this “hybrid” class of investments fit into your portfolio? Let’s take a peek under the hood of smart beta to find out.

Where returns come from

You can think of the return of any portfolio as the result of its many exposures.  Many investors compare the total return of a fund to a relevant market benchmark. This comparison helps us determine if the manager is faring well or poorly compared to the relevant opportunity set. Any return above that benchmark return is “active” – the value added by the investment manager, beyond exposure to the broad market.  A portion of that active return may be the result of the manager’s skill: their unique insights in security selection, country bets or market timing.  And a portion of that “active” return can be attributed to the fund’s exposure to style factors, like value or momentum – the very same style factors that can be captured in smart beta strategies.

The total risk and return of the portfolio is the sum of these parts — proportions will differ, but our research suggests that on average, most actively managed portfolios have significant exposures to smart beta factors. For example, an average 35% of global equity managers’ active risk is explained by smart beta, like the style factors previously mentioned; for about a third of global equity managers, smart beta contributes 50% or more of their active risk. The phenomena is even more pronounced for fixed income managers, where exposure to interest rate and credit factors account for nearly 70% of the risk in the average core plus fixed income portfolio.

The takeaway? You are probably already a smart beta investor  – chances are your actively managed funds include significant exposure to smart beta factors . We think owning smart beta is a good idea, but  you may also be paying active-like fees for those exposures. And that’s exactly the a-ha moment – smart beta strategies can efficiently deliver many of the same themes present in actively managed portfolios, with greater transparency and at a fraction of the cost.

Active, index and smart beta

The growing adoption of smart beta products should inspire all investors to examine their current portfolios. We believe investors should seek returns from every potential source – and that all investors should consider the proportion of active, passive and smart beta investments that can help meet your own investment goals.

In my next post, we’ll look forward to 2015 and how we expect smart beta to shape investment results in the coming year.

Source Url:http://www.etftrends.com/2014/12/an-investment-strategy-thats-hidden-in-plain-sight/