Advisors wondering which smart beta strategies yield the best results may be disappointed to hear that there are none that consistently outperform others.
A report from Schwab on "The Elegance of Indexing," released at this week's Inside ETFs conference shows that none of five smart beta strategies — equal weight, fundamental, low volatility, momentum or quality — consistently outperformed over the past five years ended 2016, and the same rather random pattern continued over the most recent 11 years.
"There is a natural rotation of the best and worst performing strategy from one period to the next," according to the report. "In 2015 momentum was the best performing strategy and in 2016 the worst. Low volatility performed well recently (2014-2015) but lagged in 2012 and 2013."
Smart beta strategies are often grouped together, but the reality is they are very different from each other because of how they weight securities and screen them.
"All strategies have their day in the sun," said Tony Davidow, alternative beta and asset allocation strategist at the Schwab Center for Financial Research. "You can't really time the market or know which factor does best," which is why he cautions advisors against moving from one smart beta strategy to another. Timing market factors is "a loser's game," Davidow said.
Davidow is a fan of fundamental strategy, which tends toward value, combined with a traditional market cap weight, which tends toward growth, as a core portfolio strategy. That combination "provides better diversification … and cost advantages because the market cap is typically your lowest cost solution and you get alpha, the ability to have that excess return which we find in the fundamental index strategies," Davidow said.
The fundamental smart beta strategy chooses stocks based on measures such as price to sales, cash flow, dividends and buybacks. Farhan Sharaff, senior managing director of equities for Guggenheim Partners, prefers equal weight for a core portfolio strategy. Each component of an index such as the S&P 500 has the same weight, unlike traditional indexes which weight stocks according to their market caps. Sharaff appeared on a panel at the Inside ETFs conference on smart beta as a core investment strategy.
