Smart beta added to a portfolio, or a portfolio constructed around a core holding of multi-strategy smart beta products can help diversification and spread the risk.
Vivian Tung, vice-president, BBH Exchange Traded Fund Services, believes there is plenty of choice in the market for advisers, with more providers launching smart beta products to accommodate increased market demand for such products.
With this choice comes flexibility, she says, adding: “Many advisers appreciate the added flexibility offered by smart beta indices when it comes to designing products.
“This influx of products is a good thing for investors overall but it is important they are well-versed in the various smart beta products at their disposal before deploying their capital.”
Therefore there is a need for advisers to educate their clients about what smart beta is and how it can help overall portfolio construction.
“It needs to centre around what the adviser is trying to achieve for their investors and what the investor’s objective is”, says Chris Mellor, executive director, equity product management at Source.
“If we go back to the two types of smart beta - tools and strategies - some products may be suitable replacements for existing core holdings in a portfolio, as they could offer similar returns for lower volatility, or greater returns for the same or even lower volatility.
“Advisers can also use smart beta products to create portfolios for clients that wish to generate an income in a more targeted way”.
Investors are also typically familiar with ETFs from their past use of these vehicles for market cap-based investments Bryon Lake, Invesco PowerSharesIt is all about considering how smart beta can fit into a client’s overall investment objective.
This, however, can be a challenge, as Martin Weithofer, head of strategic beta at Deutsche Asset Management, explains: “It is a challenge for advisers to grapple with the concept of smart beta and then work out how they can use it in the interests of their clients.
“They could use a model portfolio, where strategic beta is used for taking a particular exposure.”
This means advisers could look to a discretionary or wealth manager whose portfolios use smart beta to avoid a particular part of the market that is looking particularly unattractive.
Advisers can also use platforms, for example Copia’s range is available on Novia, although not all UK platforms can host either ETFs or smart-beta passive products.
Exchange-traded funds
They could also look at multi-strategy exchange traded funds (ETFs) or even single-strategy ETFs where this is appropriate.
For example, Mr Weithofer says an adviser, when speaking with the client, may come to the conclusion the client wants some exposure to European sovereign bonds, but does not want to have a high exposure to the most indebted debt issuers.
While a typical European sovereign bond index tracker may look like the cheapest passive option, it might also replicate some terrible performance.
“Most fixed income indices provide the greatest weighting to the most indebted debt issuers, which may not always be optimum. Therefore, weighting a strategic beta ETF based on credit quality, with a system in place to assess that quality, [might be a better idea]”, he says.
He adds: “So for fixed income sovereign exposure, an adviser might decide a strategic beta approach for the bond part of a client’s portfolio makes sense.”
Dave Gedeon, vice-president and head of research and development for Nasdaq Indices, says there is plenty of choice for advisers who wish to use smart beta ETFs.
According to Bloomberg data, smart beta ETFs make up about 20 per cent of all assets in domestic ETFs but there is room to grow, particularly in “multi-factored strategies”.
Certainly, Bryon Lake, head of Invesco PowerShares EMEA, believes ETFs are the most popular route so far for the retail market.
He says: “This is the most popular route for accessing these strategies, as ETFs are transparent, allowing access to the full list of holdings, can be traded intraday and are stocks-and-shares Isa eligible.
“Investors are also typically familiar with ETFs from their past use of these vehicles for market cap-based investments.”
Cost efficiency
For Eric Shirbini, global product specialist for ERI Scientific Beta, the killer argument for smart beta is cost. He says: “Advisers need to inform their clients smart beta is a more cost-effective means of generating better performance than the market cap-weighted index, compared with actively managed portfolios.”
By exposing investors to different risks than a standard index-tracking passive fund, advisers can help avoid following the index down, but there will still be periods of volatility.
“It is important not to talk about them as ‘magic bullets’ that give you more return, but as rules-based investment strategies which can be a cost-effective way to get exposure to a particular investment style”, says Ben Seager-Scott, director, investment strategy, for Tilney Bestinvest.
He believes there is a good enough range of passive strategies available for advisers to construct low-cost, effective portfolios “almost exclusively composed” of passive vehicles, although he admits explaining this is still a challenge.
Once again, it comes back to making the seemingly complicated easy to understand.
“As an industry, we are still a little way off figuring out how to explain smart beta in a straight-forward way”, says Mr Seager-Scott.
As Mr Gedeon concludes: “The conversation begins with education.”
