Investors interested in smart beta exchange traded fund strategies should consider the factor implications when constructing portfolios and better understand the drivers of risk and return within their portfolio.
On the recent webcast, Beyond Factor Fundamentals – Diagnose Your Factor Exposure, Joe Staines, Research Analyst and Portfolio Manager at J.P. Morgan Asset Management, broke down the taxonomy of factor investments. We would look at economic factors as a descriptor of risk where compensated factors cover those witha positive economic return or referred to as risk premia and uncompensated factors with no economic source of persistent returns.
These compensated factors include market risk premia like equity beta, credit and duration. Additionally, investors may also be coming to know alternative risk premia like value, trend, merger arbitrage, carry and quality.
On the other hand, uncompensated factors include broad market categories like region or sectors that don’t inherently provide persistent real returns, or macro factors like inflation and energy prices.
Joe Smith, Senior Market Strategist for CLS Investments, pointed to seven widely viewed factors that smart beta investors may be familiar with, including size, value, momentum, minimum volatility, quality, duration and credit.
“An important subset of smart beta is factors, which are broad, persistent
drivers of risk and return,” Smith said.