In the constant quest to find a “better” way to invest, smart beta has been attracting a lot of attention as a way to benefit from the positive features of both active and passive investing. Understanding what smart beta strategies really are can be challenging, especially as there are a number available. Depending on the market environment, different strategies may be more appropriate. For example, when the markets are experiencing wide swings, investors may want to look at strategies that have the potential to perform well during those times.
Smart beta versus traditional index
Smart beta differs from typical passive or index investment strategies in one major way. In a standard index fund, each stock in the fund is held in an amount equal to how much of the index it makes up. Apple, for instance, is approximately 2.9% of the S&P 500. In a traditional index fund, Apple would therefore be 2.9% of the fund’s holdings. Managers of smart beta strategies, however, weight holdings differently in order to try to benefit from certain features, known as factors that can affect performance.
Benefiting from the factors that affect performance
Research by Eugene Fama and Kenneth French in the 1990s demonstrated that certain factors, including size of a company or metrics, such as a low price to book, can have a significant impact on asset class risk, return and long-term equity portfolio performance.
Key factors affecting performance
Since the original research, many other additional factors have been analyzed over the years, but only a small number have been shown to have a significant effect on returns or risk over the long term. Six of the most common smart beta strategies focus on obtaining additional return from:
Accessing smart beta strategies
There has been significant growth in smart beta strategies over the past several years. They are available to individual investors in two primary forms:
PNC Bank, National Association (PNC Bank) offers smart beta through our PNC STAR strategy, first introduced in October 2013. PNC STAR combines momentum and trend, with a unique approach that uses a subset of sector and international ETFs.
Smart beta for turbulent markets
During periods of volatility, historically, strategies focused on quality, dividend growth and low volatility have performed well and can bring value to a diversified portfolio. As we look ahead to further market turmoil, an allocation to those smart beta strategies may provide an attractive complement to actively managed strategies.
Source: MSCI, ISI, PNC
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