As more consider the benefits of smart beta exchange traded funds, investors should also take the time to scrutinize the differences of the various factor strategies and the potential risks associated with these broad defining terms.
On the recent webcast (available On Demand for CE Credit), Just the Facts on Single Versus Multifactor ETFs, Wes Crill, Vice President, Research Group at Dimensional Fund Advisors, explained that market prices contain relevant information and it is up to the market observer to infer the right way to interpret the findings.
“One needs to have an integrated approach to systematically capture premiums. From strategy design to portfolio management to implementation, each step needs to take into account the rest,” Crill said.
An investor will have to choose the right proxy, design a portfolio to capture premiums in a diversified manner, account for trading costs and focus on premiums to find the right balance between costs and expected returns.
When trying to suss out expected equity returns, investors will also have to identify factors that could add value to a portfolio, like the small-cap premium, value premium or profitability premium. For instance, to better define the value premium, investors may look at fundamentals like book value of equity, earnings, cash flows and sales.
“Current market prices contain information about expected returns, but it takes expertise to extract and apply that information throughout the investment process,” Crill said.
As a way to tap into institutional quality portfolio analysis like the Dimensional Fund Advisor’s expertise, Michael Stephens, Portfolio Consultant at John Hancock Investments, argued that investors could consider incorporating a factor-based, strategic or smart beta ETF.