Given that investors need to allocate to equities, and that there is now a wide array of well-differentiated equity offerings available, it makes sense to use a combination of the products available to realise their objectives.
Indeed, our quantitative analysis of combining Index, Enhanced, Smart Beta and Active strategies within an equity portfolio makes the case very clearly that investors should and can allocate across all these strategies.
Given the assumptions listed in the table below, we find that an optimal portfolio would have a core of 75% in Index + Enhanced and 25% in a satellite of Active + Smart Beta.
The optimal portfolio has weighted average fee of 15 bps. Constraining the fee to 10 bps implies a shift from enhanced/active into smart beta. Increasing tracking error shifts from index/enhanced into smart beta/active.
Investors needing to take more risk to gain extra returns would put more into smart beta and active from the core, and those looking to pay lower fees would have to shift some of their enhanced and active to smart beta.