Needle in a Haystack: How to Find the Right Smart Beta Strategy

Demand for smart beta strategies is growing, and as such, supply is too. Such a crowded landscape demands investors conduct ample due diligence before choosing the right smart beta strategy to meet their requirements.

Smart beta – also known as strategic beta or factor investing – largely refers to a category of rules-based approaches to investing. These strategies seek to capture specific characteristics that traditional active managers commonly seek exposure to, and while doing so preserving the benefits of traditional indexed investments, including transparency, consistency and low cost.

Evaluating a Smart Beta Strategy

There are a range of simple and measurable metrics, such as liquidity, factor exposure, active risk relative to a broad market index, resultant performance and, of course, cost that need to be taken into consideration when evaluating smart beta ETFs.

The following is a summary of some of the key items to consider and key questions to ask when choosing the right smart beta ETF to best meet your investment requirements.

Further Considerations for Multi-Factor Exposure

For investors seeking multi-factor exposure, it is important to go one step further. The correlation between factors needs to be considered, as factors that are highly correlated may exacerbate underperformance during certain market environments. Depending on the level of experience, investors may be looking to blend a few single factor products, or perhaps use a multi-factor product which employs pre-defined rules to allocate between/among factors. Factor timing requires a sophisticated and advanced framework that may be better left up to skilled active managers. The weighting of factors is also key, as this can address investors’ targeted objectives, such as income generation or volatility reduction while still mitigating single factor cyclicality.

Questions to ask:

  • What is the correlation between/among factors?
  • Are you looking to blend a few single factor products at your own investment discretion or use a multi-factor product which employs pre-defined rules to allocate between/among factors?
  • How do you capture multiple factors in one portfolio?
  • How are factors weighted?