In this blog and at the annual Advisor Summit, we often discuss trends in the financial services industry. Strategic beta is one such trend that has certainly had its time in the spotlight over the last several years. Yet despite its #trending status, we argue that strategic beta is far from a fad. Let’s take a minute to define this concept and identify why you and your clients should be excited about strategic beta’s advantages, not just as a passing headline today, but as an investing fundamental moving forward.

Strategic beta hits the high notes

In our view, strategic beta, sometimes called smart beta, is an umbrella term for investment approaches that are systematically constructed to make meaningful tilts away from traditional market capitalization-weighted indices to enhance return or reduce risk.

Key points about strategic beta:

  • Not all indexed products are passive. Even indexed strategic beta approaches are considered active because of the meaningful style tilts taken by the underlying index compared to market capitalization weighted indices.
  • Strategic beta delivers active management at a passive price point. Strategic beta strategies are more mathematically driven than the typical traditional active approach. This allows investors to make calculated bets on what may beat the market generally at a much lower fee than traditional active management.
  • Factor-based investment products are a key subset of the strategic beta universe. Factor-based approaches systematically emphasize academically vetted, rewarded risk factors. While some exposure to the same factors may be indirectly present in a variety of different approaches, factor-based products seek to provide intentional and significant exposure to these factors.

Why strategic beta is here to stay (and who should care)

Factor research has been around for decades and came about as a rebuttal to the notion that the market factor was the only explanatory variable in deciphering expected return. However, historically, pure factor-based investing was not easily accessible to investors, and exposure to rewarded risk premia was generally delivered by traditional active managers, at traditional active fees. That has changed over the last few decades, as computing power and vast amounts of big data have become readily available. When you add in indexing capabilities and continued cost compression across the industry, we can see why strategic beta has become more relevant than ever.

Because of its mix of active and passive characteristics, strategic beta not only appeals to cost conscious clients, but also to those clients that want to outperform with active management. Factor-based approaches are particularly well-suited to serve as a replacement or complement to traditional active or traditional passive allocations. Risk tolerance and cost sensitives are key considerations to incorporating strategic beta into client portfolios.

For advisors looking to allocate their active risk and fee budgets optimally, strategic beta becomes an important tool in the arsenal by allowing clients to access key elements of traditional active investment management, but in a more repeatable, cost effective manner. Highly skilled active investment management can certainly add value, but it is generally a more expensive approach and laden with non-diversifiable manager-specific risk. You only want to pick managers with comprehensive skills that justify their higher fee, not a manager that is outperforming due to exposure to rewarded risk factors that are now readily available at a fraction of the cost with strategic beta vehicles. Focusing on a transparent, systematic approach reduces the due diligence burden of picking the next star manager as well.

Envestnet’s strategic beta resume

Even though strategic beta has not been garnering the same headlines it was a few years ago, a wealth of research supports it as far from a passing fad. PMC is a firm believer in the value of factor-based investing, and our QRG team has a legacy of managing portfolios using a factor-based approach. Further, manager research, including on strategic beta and factor-based managers, is a core competency of our research team. As the steady drumbeat of cost compression collides with the need for outperformance in a world of low expected returns, we believe interest in strategic beta may continue to grow, and PMC is ready to be your partner in that progress.

For a deeper dive into strategic beta and multiple perspectives from industry experts, check out my 2021 Advisor Summit On-Demand panel. In the presentation, we spend more time breaking down the active vs. passive aspects of strategic beta and how factor investing fits in to modern portfolio strategies, among other topics. This session is currently available for 1.0 CFP® credit or 1.0 CIMA® credit.

Visit our strategic beta page to find resources that explain strategic beta and Envestnet PMC’s strategic beta ETF ranking methodology. To learn more about Envestnet’s take on factor investing, check out QRG’s Factor Strategies approach.

The information, analysis and opinions expressed herein are for informational purposes only and do not necessarily reflect the views of Envestnet. These views reflect the judgment of the author as of the date of writing and are subject to change at any time without notice. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

Written By:

Sarah Abernathy, CFA, CAIA, VP • Senior Investment Analyst, Envestnet
Sarah Abernathy, has spent her career assisting RIA, bank, and broker dealer home office clients and their advisors with money manager research, due diligence, and selection, as well as advising on asset allocation, capital market assumptions, and tax optimization. Mss. Abernathy holds a bachelor’s degree with dual majors in Finance and Economics, and a minor in Spanish, from the University of Northern Iowa.  She has earned the CFA and CAIA charters, and is a member of the CFA Institute, the CFA Society of Iowa and the CAIA Association. 

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