I was researching what is known as “Smart Beta,” and I had no idea that some publications think that 2015 is going to be the year of Smart Beta. Many in the industry think Smart Beta is stupid. I agree but for a completely different reason as you’ll read below.
What is Beta? Not everyone who reads my newsletters knows what Beta is. Beta is a volatility measurement for investments. The benchmark most use when discussing Beta is the S&P 500.
When setting a benchmark to compare other investments to, you set the benchmark at 1.00. Therefore, when an investment has a Beta HIGHER than 1.00, it is seen as more volatile than the benchmark; and when an investment has a Beta LOWER than 1.00, it is less volatile.
What is “Smart Beta”?
Investment News says that Smart Beta “is identified as alternative beta, fundamental indexing, enhanced indexing and more. But it really just comes down to tweaking traditional indexing by weighting stocks based on metrics other than the market capitalization of the underlying companies.”
To me, Smart Beta is mostly a marketing term used by financial planners or firms trying to justify fees. As I discussed in last week’s newsletter titled When Underperforming the S&P 500 is a Good Thing, the general public has been nearly brainwashed to think that the benchmark for their liquid investments is the S&P 500 stock index. This is a recipe for disaster as I indicated last week.
Those who promote Smart Beta tout that by slightly tweaking the use of a stock index, they can create a portfolio that beats the index. Statistical data suggests that’s a fallacy and many commentators also say there is NO SUCH THING as Smart Beta.
Why I think Smart Beta is stupid
For me, the idea of Smart Beta is stupid because it’s unlikely that it can beat just leaving invested money in the indexes. I don’t like Smart Beta because it doesn’t cure the flaw with any indexing strategy. What flaw is that? Investment risk!
Let me restate one of my favorite sayings that EVERY client and financial planner should adhere to: investors should always take the LEAST amount of risk to reach their investment goals.
If it is true that EVERY client and financial planner agrees with the previous statement, then indexing should not be used as a tool to grow a client’s wealth.
The following example will support my position.
Investment #1 Expected rate of return = 8%
Maximum drawdown risk going back 10 years of -50% (the maximum drawdown of the S&P going back 10-years).
Investment #2 Expected rate of return = 8%
Maximum drawdown risk going back 10 years of -5%
Which one 100% of the time should a client want and should an advisor recommend? Investment #2
Tactically Managed Strategies
I have been talking about the very unique platform offered by www.pomplanning.net for nearly two years now. In that time frame, over 150 advisors have come on board and have made it one of the fastest growing RIAs in the industry (almost $575 million in new AUM as of October, 2015).
Why is it one of the fastest growing RIAs in the industry? They now have 15 different what I call low-drawdown risk/tactically-managed strategies.
The Beta on eight of their strategies is 0.40 or less with returns that should be very acceptable to most investors. To learn more about these low drawdown risk strategies, simply go to www.pomplanning.net/annual.numbers.
So, again, why do I not like Smart Beta? Because using a Smart Beta investment strategy violates my #1 rule when it comes to picking investments (investors should always take the LEAST amount of risk to reach their investment goals).
Regardless of my opinion, it seems that Smart Beta is a term financial planners will have know and deal with in 2015.
Roccy DeFrancesco, JD, CWPP™, CAPP™, CMP™
Founder, The Wealth Preservation Institute
144 Grand Blvd
Benton Harbor, MI 49022