Many of the questions zeroed in on particular aspects of the tactical strategies used by our respective firms. One advisor raised a counterpoint: Isn’t there a risk of lagging because the portfolio is invested in cash when the market rebounds? The question is a powerful one and reminds investors that strategies offering downside protection can incur a “cost of protection” that can lead to difficult performance periods.
Representing CLS, my core approach differed from the other three panelists, who tended to raise and lower risk levels. We think the target risk level and active management can be separated. Our primary strategy seeks to maintain a target risk level and then reallocate that risk as conditions and expectations change. This is one approach that allows the portfolio to adjust to opportunities while staying consistent with the risk desired in the client’s financial plan.
Growth and Barriers in Factor Allocation
“Do you use smart beta as a complement or replacement for market-cap strategies?” The answers to this question showed how smart beta has permeated many portfolios. It also exposed some of the barriers to further expansion.
Most of the panel was smart beta agnostic: They were willing to use the standard index or the smart beta ETF, based on which had the best performance characteristics. Considering how new smart beta strategies are, this is a big achievement.
Panelists and attendees remained leery of how the factors will perform now that investment vehicles exist to take advantage of the trend. There is a combined $15 billion invested in just two ETFs focused on reducing volatility in large-cap domestic equities. Both were launched in 2011. It stands to reason the assets in those ETFs will change the expected return from low-risk stock portfolios in coming years.
Tentative Steps Forward
The experience left me with a pair of conclusions. First, investors are balancing the opportunities provided by smart beta ETFs with past experiences of getting burnt by the next great thing. Our research into smart beta shows the majority of strategies offer the potential for long-term gains, but investors should still pay attention to valuations and other fundamental factors.
Second, advisors and investors are clamoring for firms to use smart beta ETFs, while rotating out of them when the factor isn’t favored. Advisors are looking for experts in smart beta to help them allocate and adjust their portfolios to changing conditions. Based on the questions, they are looking for help in making those decisions. Given the strength of our panelists and other firms, they will have some strong choices.
This information is prepared for general information only. The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change. 1264-CLS-3/2/2016