A rising number of investors have adopted smart beta ETFs in a diversified portfolio to access investment styles traditionally associated with actively managed portfolios. According to John Hancock, 84% of advisors utilize ETFs and 69% of portfolios using ETFs included strategic beta exposure. Financial advisors typically utilize ETFs three ways: a handful of heavy users, a vast majority fall under the blended category where they use ETFs as a core component, and lastly dabblers dip their toes in or look for quick exposure.
Given the rising demand for smart beta strategies, it is important for investors to fully understand what they are getting themselves into. Stephens illustrated a typical 60/40 portfolio of equities and bonds, but he incorporated some of the most popular factor ETFs as major core components. For instance, if the U.S. minimum volatility and U.S. dividend factors were main components of a portfolio, Stephens warned that an investor would be overweight utilities and underweight technology under the U.S. equity sleeve.
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If one focuses too much on single factor ETFs, an investor may run the risk of overweighting toward specific sectors or areas of the market that could have unintended consequences.
“I think single factor funds lend themselves more to ancillary positions in portfolios rather than the core,” Stephens said. “Remember that often factors like ‘low vol’ don’t come for ‘free’ – they are a way to tilt your portfolio a certain way. When using strategic beta for ‘core’ exposure, treat it like you do all of the other parts of your portfolio and diversify. But this one is tricky. You can’t go out and buy three single factor ETFs and get the same result as a multi-factor ETF.”
ETF investors whore are interested in a strategy that combines market factors to smooth out the ride can look to a number of multi-factor, smart beta ETFs in the market. For instance, John Hancock has a suite of smart-beta ETFs that track indices developed by Dimensional Fund Advisors, including the John Hancock Multifactor Large Cap ETF (NYSEArca: JHML) and John Hancock Multifactor Mid Cap ETF (NYSEArca: JHMM), along with sector-specific John Hancock Multifactor Consumer Discretionary ETF (NYSEArca: JHMC), John Hancock Multifactor Financials ETF (NYSEArca: JHMF), John Hancock Multifactor Healthcare ETF (NYSEArca: JHMH), John Hancock Multifactor Technology ETF (NYSEArca: JHMT), John Hancock Multifactor Consumer Staples ETF (NYSEArca: JHMS), John Hancock Multifactor Energy ETF (NYSEArca: JHME), John Hancock Multifactor Industrials ETF (NYSEArca: JHMI), John Hancock Multifactor Materials ETF (NYSEArca: JHMA) and John Hancock Multifactor Utilities ETF (NYSEArca: JHMU).
The smart-beta ETFs’ underlying indices select components based on company size where a premium is given on smaller companies over larger companies, relative price where value stocks are selected over growth and profitability where more profitable companies are overweight.
Financial advisors who are interested in learning more about factor-based, smart beta ETF strategies can watch the webcast here on demand.