Limit Risks and Diversify with Multi-Factor, Smart-Beta ETFs

Exchange traded funds (ETFs) that implement smart-beta strategies help investors move away from traditional market-cap methodologies to generate better returns without paying for the high costs associated with an active manager.

On a recent webcast, How Smart Beta is Getting Smarter and Why Advisors Should Pay Attention, Eric Shirbini, Global Product Specialist at ERI Scientific Beta, highlighted some shortcomings associated with market cap-weighted index funds, including a tilt toward unrewarded factors and low level of diversification, which may lead to less desirable risk-adjusted returns.

Consequently, fund providers have worked with indexers to create smart-beta indices to address the problems. In the beginning, we saw so-called smart-beta 1.0 solutions, or strategies with a single factor tilt, like value or equal weight. Now, the industry has come out with smart-beta “2.0” indices that utilize factors based on well established empirically rewarded factors and multi-weighting strategies that weight components to maximize diversification.

“Many rewarded factors are under-represented in client portfolios,” Joe Smith, Senior Market Strategist at, CLS Investments, said.

For instance, on the webcast, 63% of polled advisors are not allocated toward smart-beta strategies. However, the majority of advisors, 56%, say they are adding smart-beta ETF exposure over the next six months. About 27% of surveyed advisors, though, require more information, which reflects the ongoing need to educate investors about alternative index-based strategies.

Smith advised investors to focus on long-term, rewarded sources of risk while minimizing exposure to unrewarded risks as a way to steer toward broad and consistent drivers of superior returns.