Dynamic Market Exposure with Smart Beta ETFs

As investors look beyond traditional market-cap weighted investments in an extended bull market environment, many are turning to smart beta or factor-based ETFs to diversify and potentially enhance returns.

On the recent webcast (available On Demand for CE Credit), Dynamic Approaches to Factor Investing, David Mazza, Head of ETF Investment Strategy and Beta Solutions at OppenheimerFunds, explained that smart beta is supported by factor investing where they exhibit both actively managed and passive index-based investment styles.

“Smart beta is a transparent, rules-based investment approach that sits at the intersection of actively managed and traditional passive portfolios,” Mazza said.

Investors have jumped on the smart beta investment train for a number of reasons, including risk reduction, return enhancement, improved diversification, cost savings, specific factor exposure and income generation. Looking back, some of these factor-based or smart beta strategies have been adopted by many investors over the years. Academic support and existence of factor investing has been prevalent for over half a century, Mazza said.

“With the emergence of Smart Beta, the old separation of alpha and beta has been transformed to include factor betas,” Mo Haghbin, Head of Product and Beta Solutions for OppenheimerFunds, said.

When picking out a factor, Haghbin argued that investors should consider the characteristics that define a “rewarded factor,” or academically proven characteristics that help explain a security’s risk and performance. Specifically, a rewarded factor needs to hold over long time periods, hold across sectors, hold for various definitions, provide logical explanations for its premiums and show results after implementation.

Haghbin focused on six factors that meet the rewarded factor criteria, including value, quality, size, low-volatility, momentum and yield.

Value refers to stocks that appear cheap tend to outperform expensive stocks. The factor is based on cash flow yield, earnings yield and price-to-sales ratio.

Quality refers to higher quality companies outperforming lower-quality companies. The factor is based on profitability, efficiency, earnings quality and leverage.

Size refers to smaller companies outperforming larger company stocks. The factor is screened by full market capitalization.