Better Index Investing: Constructing Smart Beta Portfolios

With talk of strategic—or smart—beta increasingly becoming more prevalent across the investment landscape, we ask Yaz Romahi, portfolio manager and CIO for Quantitative Beta Strategies, about how portfolio construction is as important as factor exposures in solving for potentially smoother returns.

Yaz, what is your approach to portfolio construction?

If we see strategic beta as an alternative to traditional index investing, it is worth bearing in mind why investors choose index funds in the first place. An index fund is meant to provide investors with diversified exposure to capture market returns. Investors do not expect such funds to be biased towards any particular concentration of risk.

Smart beta indices have been mainly focused on building in factor exposures—for good reason—to access other sources of economic return. However, there is another dimension that is often ignored: the risk dimension. Indeed, it is no surprise to most people that market cap indices are highly concentrated. The top 150 stocks in the S&P 500 Index, for example, represent most of its risk!* Sector exposures can also be very concentrated and—worse—unstable.

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