Smart beta ETFs may sound like a catchy sales pitch the industry has crafted, but the ETF strategies have backed up their claim as a smarter way to access the markets.
“While industry marketers have glorified the term, smart beta strategies continue to grow in popularity because, compared with market-capitalization-weighted strategies, they allow investors to exert more control over their portfolio outcomes in the face of an increasingly challenging investment environment,” David Mazza, Head of Beta Solutions Investment Marketing and ETF Specialists for OppenheimerFunds, said in a research note. “Smart beta may feel like a fad to some, but we would argue that this approach is on track to join active and passive management as part of the investing establishment.”
Smart beta or factor investing is a low-cost, rules-based approach that may provide investors with improved returns, lower risk and better diversification, compared to traditional beta index funds, Mazza argued.
This alternative indexing style sits between traditional passive and actively managed styles as smart beta offers some of the benefits of both worlds.
Similar to actively managed portfolios, smart beta strategies may strive to achieve exess returns beyond passive, market cap-weighted methodologies and may also diminish portfolio risk through rules-based security selection. Additionally, like traditional passive indexing, smart beta is low cost, is fully transparent and provides tax efficiency through the ETF investment vehicle.
Smart beta may be the hot topic in today’s financial world, but the concept has been around for decades and is supported by extensive academic and practitioner research that is largely focused on factor-based investments. Many active strategies have also incorporated these factor-based investment approaches, and research has shown that a significant portion of returns derived from active management can be explained by exposure to specific factors.
“Today, as smart beta has evolved, a more nuanced interpretation of alpha has emerged that attributes a portion of alpha to factor betas, such as value, momentum, size and quality,” Mazza said.
Mazza argued that there are three distinct types of smart beta strategies, including alternatively weighted, single-factor and multi-factor.
Alternatively weighted includes a portfolio that incorporates traditional benchmarks but weighted beyond traditional market capitalization or by a company fundamental, such as revenue.
For example, Oppenheimer offers a line of revenue-weighted options like the Oppenheimer Large Cap Revenue ETF (NYSEArca: RWL), Oppenheimer Mid Cap Revenue ETF (NYSEArca: RWK), Oppenheimer Small Cap Revenue ETF (NYSEArca: RWJ), Oppenheimer Ultra Dividend Revenue ETF (NYSEArca: RDIV) and the Oppenheimer Financials Sector Revenue ETF (NYSEArca: RWW).
The single-factor approach includes specific style factors, such as value, quality or momentum, to exploit the power that these factors may provide.
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Lastly, multi-factor strategies combine two or more factors to construct portfolios that will meet specific objectives in an attempt to provide a better core holding for investors than any single-factor approach could be and capitalize on the power of diversification to meet a specific outcome.
For more information on alternative indexing strategies, visit our smart beta category.