Investors who are interested in smart beta or factor-based ETFs should consider some of the best practices when incorporating these alternative strategies into a diversified portfolio.

On the recent webcast (available On Demand for CE Credit), Core Values, Core Portfolio Building Blocks, Lance Humphrey, Portfolio Manager for USAA Asset Allocation, warned that current valuations in U.S. stocks are elevated in the extended bull market environment. Furthermore, fixed-income assets are also exhibiting stretched valuations and low yields after a three-decade bull run.

Consequently, Humphrey argued that investors could look to smart beta or factor-based strategies that eschew traditional market capitalization weighting methodologies to seek out ways to access the markets and diminish potential risks along the way. Specifically, at USAA, the smart beta approach should track core factors, offer balanced risks, include thoughtful implementation and provide consistent returns.

The core factors include securities that should be selected using the most researched and empirically validated factors from both academic and practitioner research. Smart beta should provide balanced risk or stocks selection should be weighted in a portfolio in such a way to balance the risk of each individual security. Through thoughtful implementation, indices should be constructed thoughtfully to account for implementation concerns such as turnover, liquidity, and rebalancing. Lastly, the investment should provide consistent results by combining complementary factors in a balanced approach, which can lead to more consistent results relative to market capitalization weighted indices,

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