Smart beta exchange traded funds have hit the industry by storm, but what exactly are smart beta ETFs and how do they fit into a diversified investment portfolio?
“Smart beta products seek to capture the persistent excess returns in the market with transparent, rules-based, factor tilts. By combining elements of traditional passive and active management, smart beta retains the benefits of cap-weighted indices but removes a known inefficiency, an asset’s price, from its weighting,” Mo Haghbin, Head of Product, Beta Solutions at OppenheimerFunds, said on the recent webcast, The Evolution of ETFs Through Factor-Based Indexing.
Haghbin argued that smart beta strategies can act as a central portfolio investment to help investors reach desired outcomes. While smart beta ETFs are still fundamentally passive in nature, they follow a rules-based indexing methodology that target factors like momentum and quality, among others, that help an investor outperform, similar to what active managers try to achieve.
As the ETF industry continues to develop, more have seen the benefits of these alternative index-based strategies like the desire to diminish risk or maintain diversified exposure through various market cycles, fueling the ongoing growth. Smart beta ETFs have seen an annual 28% growth rate in assets over the past five years.
According to a recent FTSE Russell survey, investors use smart beta based on their objective, with most citing reasons like risk reduction, return enhancement, improved diversification, cost savings, specific factor exposure and income generation. Among the most popularly followed factors, Haghbin pointed out that investors typically look to value, size, yield, quality, momentum and low volatility, along with multi-factor strategies that combine two or more of these single factors.
“Following the Global Financial Crisis, managers began to develop more sophisticated Smart Beta strategies better positioned to weather volatile markets, especially risk-oriented funds,” David Mazza, Head of Beta Solutions Investment Marketing and ETF Specialists at OppenheimerFunds, said. “While this exponential growth is a small part of all Passive Funds and ETFs, Smart Beta strategies are becoming a part of every investors toolkit to generate outperformance for their clients.”
At Oppenheimer, they believe that revenue-weighting is one way to help investors potentially enhance returns and diminish risk exposure. Due to the revenue-weight tilt, investors won’t be exposed to trendy, overpriced stocks that market cap-weighted indices are prone to be, and investors will hold companies with more attractive valuation characteristics with a slight value tilt.
“By rebalancing the portfolio every quarter towards companies that have had persistent sales, revenue weighting keeps the portfolio from getting ahead of itself in overheating markets like the tech bubble of the early 2000’s,” Mazza said.
OppenheimerFunds offers a suite of revenue-weighted ETFs that specifically focus on companies with high revenues, including the Oppenheimer Large Cap Revenue ETF (NYSEArca: RWL), Oppenheimer Mid Cap Revenue ETF (NYSEArca: RWK), Oppenheimer Small Cap Revenue ETF (NYSEArca: RWJ), Oppenheimer Ultra Dividend Revenue ETF (NYSEArca: RDIV), Oppenheimer Financials Sector Revenue ETF (NYSEArca: RWW), Oppenheimer ESG Revenue ETF (NYSEArca: ESGL) and Oppenheimer Global ESG Revenue ETF (NYSEArca: ESGF).
Financial advisors who are interested in learning more about smart beta or factor-based index ETFs can watch the webcast here on demand.