Investors carefully weigh the hidden risks of traditional cap-weighting methodologies and consider strategic beta or alternative index-based exchange traded funds strategies to diminish the risks while still maintain some upside potential.

On the recent webcast, Moving Beyond Cap-Weighted Investing For Today’s Volatile Market, Mark Hackett, Chief of Investment Research at Nationwide, looked at the U.S. equity bull run, adding that markets saw a record 15 months of back-to-back positive returns in the S&P 500 between October 2016 and January 2018. However, the pendulum swung violently in February, with average daily moves in 2018 about three times that of 2017 and twice as many 1% or greater moves this year than all of last year.

“Investors are very reactive to news headlines, including fears of trade wars, inflation and political turmoil, which is very different from the behavior from last year,” Hackett said.

Hackett also added that investors should be looking beyond the short-term noise as strong fundamentals will continue to support the markets. Global economic growth remains outstanding, with the OECD recently raising their growth estimates for global GDP to 3.9% for the next two years, compared to 3.7% last year. Meanwhile, the U.S. is expected to experience 2.9% and 2.8% growth over 2018 and 2019, respectively. The stronger economic backdrop has also fueled robust earnings growth.

“Contributing to the strength is a weak dollar, accelerating capex, operating leverage, the impact of rising rates on banks and higher energy prices. This could be the fastest economic and earnings growth of the current expansion, which would be quite unusual given where we are in the business cycle,” Hackett said.

Consequently, as investors approach the current markets, many are considering ETFs, and the topic of ETFs is starting to dominate the conversation, Shana Martin, ETF Product Manager at Nationwide, said. Additionally, Martin pointed to the growth of strategic beta ETFs that are passive in nature but follow a rules-based indexing approach.

“Strategic beta is a subset of passive but rather than following a market-cap weighted approach these strategies follow other stock selection and weighting methodologies. These strategies are rules driven like passive but often utilize factors to select stocks similar to active strategies,” Martin said.

Looking ahead, Martin does not believe the U.S. will be able to enjoy a smooth, back-to-back push higher similar to what was experienced in 2017. Consequently, strategic beta may be a way for investors to capture any further upside potential while mitigating potential short-term drawdowns.

Subscribe to our free daily newsletters!
Please enter your email address to subscribe to ETF Trends' newsletters featuring latest news and educational events.