With financial markets quietly grinding higher in recent months, I've been able to complete one of my major projects for the year, which was to investigate so-called "smart beta" mutual funds. As a primer, "smart beta" funds are also known as "strategic beta" funds, and are based on academic research that certain attributes of individual stocks indicate future outperformance.
We recently discussed in "Value is Trumping Growth", from a series of Articles on Wealth Management Topics, one of the original and most widely-used "smart beta" factors, namely the "value" factor. That is to say that stocks that have low prices relative to their earnings, or to their book values, or to their revenues, or to their cash flows, tend to outperform the markets over long investment periods. Other widely-accepted "smart beta" factors include:
• Size: small-cap stocks tend to outperform;
• Low Volatility: stocks with relatively stable prices tend to outperform;
• Quality: stocks with solid balance sheets and dependable earnings tend to outperform;
• Momentum: stocks that have performed well recently tend to continue to outperform.
Much of this underlying research has been around for decades. (In fact, I've been using the value, size, and momentum factors to pick stocks for myself since the '90s). And if you've ever seen a value or small-cap mutual fund in your retirement plan, or have been invested in one, then you've had experience with "smart beta" factors.
The concept of "smart beta" investing has really taken off in recent years, though, with a tidal wave of new investment products being introduced and with marketing material galore being distributed to support them. So the objectives for my Project "Smart Beta" became to revisit the original academic research, to sift through this marketing material, and to investigate the range of "smart beta" investment products:
(1) to determine which, if any, additional "smart beta" factor exposures to add to client portfolios, and
(2) to determine which mutual funds to use to gain these exposures.
After digesting books, research pieces, white papers, Morningstar fund screens, internet searches, and phone calls, I've decided on introducing 8 or 9 new "smart beta" exchange-traded funds (ETF's) to client portfolios incrementally as opportunities present themselves. Some of these ETF's will provide exposure to single "smart beta" factors that haven't yet had a place in client portfolios and will diversify the "value" and "quality" tilts already there. Some will access the existing "value" and "quality" exposures in a different or more targeted manner. And others will be stand-alone investments designed to combine exposures to multiple factors in one ETF.
In no way do I feel that these (or any "smart beta") ETF's are silver bullets making all other mutual funds obsolete. But they are worthy additional arrows in our investment management quiver. If you'd like to discuss "smart beta" mutual funds, or their place in your portfolio in more detail, please feel free to drop me a line.
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.