Advisors Evolve in Use of Smart Beta ETFs

The day before the Republican primary debate in Houston, I participated on a panel at a smart beta symposium put on by S&P Dow Jones Indices.

While our panel wasn’t quite as raucous as the Republican debate, it wasn’t without surprises.

In this case, the surprise came from the audience’s questions.

While the panel of ETF experts focused on methods of evaluating smart beta ETFs, the questions from the people in attendance and those watching the live stream, leaned heavily on the strategies used by each participant.

The emphasis on strategy over ETFs was a refreshing change. More advisors seem to be moving beyond trying to figure out which quality ETF to use in their allocations or the correct way to employ low-volatility ETFs. Instead the focus is shifting towards clients – specifically, the areas of risk management, tactical allocations, and factor allocation.

A Valuable Tool in Risk Management

Smart beta ETFs have become a central tool for managing risk in portfolios. Reduced-volatility ETFs allow investors to reduce the risk of their equity investments without making drastic changes to the underlying portfolios. Index results and academic studies often show these strategies reduce risk while improving results.

ETFs investing in quality companies provide an additional way to modestly reduce risk. Quality companies are better prepared to weather the ups and downs of business cycles and hiccups that all companies invariably face. Healthy businesses translate into less risky stocks.

The other common smart beta factors tend to be more volatile than the rest of the market. Emphasizing smaller companies (size), cheap stocks (value), and good performers (momentum) can also benefit returns, but this generally increases risk.

Some Consensus: We’re All Tactical

Advisors peppered the panel with questions about our strategies. All four of us were active or tactical in some fashion. This isn’t surprising; ETFs have become the tool of choice for active asset allocation firms. They offer a wide range of asset classes, are generally liquid, and are structured so rapid that trading doesn’t harm other shareholders.