As demand grows for smart beta strategies in the UK, how can investors assess the risks and rewards of these diverse investment vehicles?
Investment Week is hosting a debate, sponsored by Lyxor ETF, on this issue every day this week with guest contributors giving their views on both sides of the debate.
You can join the debate by clicking here or on Twitter @InvestmentWeek #IWDebates
A few years ago, smart beta strategies were only just entering the UK market and many investors considered them risky and confusing. However, more and more allocators are now using these vehicles today within portfolios for various purposes.
Smart beta strategies focus primarily around factor investing, which aims to single out exposure to specific risk factors, such as momentum, value and size.
They have become particularly popular with investors recently in light of a shift towards value investing, which has underperformed growth for the past decade but looks set for a turnaround.
However, as the popularity and proliferation of these strategies grows, so does their complexity and the difficulty of separating the wheat from the chaff, as not all smart beta products are made the same.
To kick off the debate, Investment Week founding editor Lawrence Gosling analyses the benefits and risks of smart beta strategies.
He says he is impressed with the "intellectual rigour which sits behind the factors comprising the funds", but also understands how some investors think marketing is taking over for these products.
Gosling concludes by saying it is the role of advisers and researchers to cut through the marketing and make their own final decisions on the products.
Joining the debate, Allan Lane, founding partner of Twenty20 Investments, gives his view that hedge funds have been relegated from the 'smartest guy in the room' to the 'last guy to the room' because of the onslaught of smart beta strategies. He highlights the evolution of a much broader set of smart beta indices than were available ten years ago, including areas like fixed income.
However, he also acknowledges smart beta ETFs "move the goalpost, somewhat ironically, to a playing field where one has to try harder to make the most out of the securities available, and it feels that not all investment management firms have the right tools or platform to make the most of the smart beta opportunity".
Meanwhile, Solomon Nevins, investment manager at Architas, argues "like courgetti and the term 'big data', I suspect that 'smart beta' may be just another fad instead of the game-changer that marketers would have us believe".
He says a smart beta approach has its limitations for equity investors but makes more sense in fixed income.
Nevins adds that, in principle, giving investors the precise tools to access factors, such as small cap, value or quality, is a good idea but they should be accompanied by a framework that aids the decision-making process.
"Investors should expect to rotate between smart beta funds in order to avoid periods of underperformance but to do this they need the necessary information," he says.
Guest speaker Adam Laird, head of passive investments at Hargreaves Lansdown, notes smart beta is the "real deal" if it is used to fill a hole in an investor's portfolio.
He says: "Traditional index investments are a good starting point for most, but there are goals a traditional market-cap index simply cannot meet."
He highlights three key advantages of smart beta investing over active funds - transparency, consistency and cost.
Laird agrees with Nevins that investors cannot expect a smart beta ETF to outperform forever, but notes this cannot be expected from any fund, active or passive. To mitigate this risk, investors must be selective, he says.
Offering his typical contrarian view, Investment Week's columnist David Stevenson is not convinced by the 'smart beta' label, saying "if smart beta was just about democratising quant investing, I think we'd all sign up".
"If retail investors or even their advisers genuinely understood why sometimes value works but other times momentum trumps it, I'd say that smart beta/quant could absolutely go mainstream," he says, but he argues the concept is too complicated for the average retail investor to understand.
He is particularly concerned about what happens "when the pointy heads are let loose and they hatch multi-factor strategies involving more ingredients than a mixed vegetable Balti".
In the third day of Investment Week's live debate Allan Lane and Soloman Nevins offer rebuttals to the arguments put across yesterday.
Twenty20 Investments' Lane notes smart beta is the investment industry's contribution to the "ongoing tech revolution".
He says whether this is a fad or not is "besides the point" and mainstream clients are "aching" to feature these types of products in portfolios.
Architas' Nevins also re-joined the debate saying the term 'smart beta' lulls investors into believing they have the "holy grail of outperformance in all environments".
He says achieving a blend of active, trackers and smart beta would lead to a more "sustainable approach".
