Smart beta. A different style of investing

If investing jargon is all Greek to you, then smart beta may not initially appeal! However, smart beta represents an alternative style of investing, to add to the more familiar active and passive investment styles.

Asset allocation arguably has the biggest impact on your investment portfolio returns. However, after establishing your asset allocation, an important decision remains. What investment style should you adopt when investing in each asset class?

Until fairly recently, there were two predominant styles; active and passive. Active investing sees fund managers making investment choices on a regular basis, buying or selling holdings when they believe they can make a peak profit.

Active management seeks to produce a return that is superior to the market as a whole or in some cases to protect capital and lose less value if markets fall. Actively managed funds offer the potential for significantly higher returns than the market if the fund manager makes the right calls. However, an active strategy requires extensive research and constant management and so the costs are higher.

Passive investing emerged later. In simple terms, money is invested into funds linked to indexes, such as the MSCI World Index. With minimal trading and research required, costs are much lower.

Whilst passive funds can make sense for the more cautious investor, it does mean you are tied to that index, which is fine when markets are bullish but less fun when tracking downwards. Active funds can more easily reduce exposure to underperforming sectors of the market.

Smart beta investments take on elements of both active and passive investing. They still aim to passively track an index of investments, but look to address the perceived flaw in the passive approach – that trackers tend to be weighted according to the market capitalization of the companies. This means that the larger the company, the larger an investor’s holding of it. Experience has taught us that bigger isn't always better.

Smart beta looks to generate returns by using a "rules based" approach that puts more weight on different investment factors, such as value (stocks that are relatively cheap when they are bought and outperform over time), momentum (winners tend to keep winning while losers keep losing), and size (smaller stocks tend to beat larger stocks), plus dividends, low-volatility and quality. These factors are used to determine which companies to own and how much of their stock to buy. Being part way between active and passive investing, the costs of smart beta naturally fall between the two.

Smart beta is not a new concept - the oldest smart beta exchange-traded funds (ETFs) appeared well over a decade ago – but they have seen a rise in popularity recently.

At Kellands, we recognise that both active and passive investment strategies have their merits. Passive funds offer a return close to the market with minimum cost, while active funds have the potential to outperform.

Passive and active funds will outperform in different asset classes over different periods, depending on a whole range of underlying factors. And smart beta could possibly now be added into the mix.

The good news for investors is that you don’t have to select just one investment style. Funds can be blended in different proportions to ensure an outcome that is close to the client’s risk tolerance and capacity for loss.

For example, a typical cautious client might have 20% in passive funds and 80% in active funds, with 50% in equities and property, 35% in bonds, and 15% in cash.

A more adventurous client would have a portfolio that reflects a higher risk tolerance. This might possibly lead to a portfolio with 100% in active funds and an 80/20 split between equities and bonds. Obviously, these are just examples.

For more information about smart beta and other investing styles, contact Kellands.

< back to News & Views

News & Views

May 23, 2024

How could stealth taxes affect your wealth in 2024?

In the past four years, many aspects of your financial life may have changed.
Read more