Smart beta is the Swiss Army knife of the investment world.
Smart-beta products reorganize indexes in a variety of ways to
tilt portfolios in multiple directions, trying to exploit
volatility or capture value or ride momentum. But new research
suggests that many of these vehicles may simply be dressed-up
performance chasers. To succeed with smart beta, investors
should focus more on what a product is actually doing and less
on the popularity of a specific factor.
David Underwood, an assistant chief investment officer at
the $33 billion Arizona State Retirement System, has been
working on indexing for more than two decades. Like any
strategy, it calls for discipline, he says. ASRS, which started
doing its own indexing to help with risk management in its
equity holdings, expanded that effort into building a broader
multifactor smart-beta portfolio.
As a result of this work, the pension fund also seeded three
low-cost factor-based exchange-traded funds offered by iShares.
Those products, which track momentum, size and value factors,
launched in 2013. In the U.S.,
smart-beta ETF products swelled from $61 billion to $377
billion in assets between 2009 and 2015, the Nasdaq Stock
What we wanted to address initially was risk-factor
alignment across the total portfolio, Underwood says. The
multifactor approach allows Underwood to dial up or down
certain factor exposures as market conditions change. Its
vital to be clear on what stocks underpin each factor product,
he says: You have to get under the hood with these
products, which is a question of resources from the standpoint
of the investor and what they are able to spend the time on and
Just ask Anthony Davidow, alternative-beta and asset
allocation strategist at the New York office of Charles Schwab
& Co. Davidow operates a think tank inside Schwab, which
runs $11 billion in smart-beta strategies, aimed at showing
investors how factors work. He too advocates a multifactor
approach to smart beta but warns that to get results, investors
may have to take steps like boosting their value exposure when
everyone else is diving into quality.
Thats not an easy conversation, Davidow
admits. We often tell our clients that what seems like a
bad idea on the surface is probably what you want to do. If you
follow the crowd every time, its more likely youll