If you invest in a smart beta ETF, it's sometimes good if its performance is poor. That's according to John Ameriks, Principal at Vanguard's Quantitative Equity Group, speaking at Inside ETFs 2018.
His argument is based on the premise that a lot of factor-based ETFs don't deliver their factor that well. So, for example, there are some value ETFs that have a very modest value tilt, or maybe don't deliver any value tilt at all compared to the main index. (Say the S&P or FTSE 100.) And there are other value ETFs that are much more focused on value stocks in the market.
The distinction is important because many investors are using factor-based ETFs to get portfolio diversification. So, for example, your portfolio may have a strong value tilt and you could decide to put money in a low volatility ETF to diversify your portfolio and reduce risk.
I've done this myself. I know my portfolio has a momentum/growth tilt thanks to shares in the likes of Amazon and Alphabet. To diversify, I've put a small amount of money in a couple of low volatility ETFs. So if my momentum stocks do well in 2018 and my low volatility funds don't do so well, that's fine. It's pretty much what I expect. But if the reverse happens, I'll be happy I got some diversification with my low volatility ETFs.
The thing that would make me really angry would be if I discovered that my 'low vol' ETFs weren't really 'low vol'. Then I'd see my momentum stocks doing badly, and my low vol ETFs doing badly even though other low vol ETFs did better because they had focused on investing in true low volatility stocks.
The phenomenon of factor ETFs that don't really deliver their supposed factor is one reason why analysis is so important. And it's a popular talking point at the conference. Investors and advisers need simple analytical tools that can tell investors whether their portfolio is tilted towards value or momentum or whatever. And they also need tools that evaluate etfs and say whether an ETF with 'value' in the name really delivers value.
The ever-rising number of ETFs also increases the need for high quality analysis. As Mark Carver, Head of Factor Index Products at MSCI put it: 'Choice is good, confusion is bad.'
Another big talking point at this morning's smart beta panel was multi-factor investing. Jae Yoon, CIO at New York Life Investment Management, said that 'adaptive multi-factor' could be a growth area. That means adjusting the mix of factor weightings in a multi-factor fund depending on macro conditions and where we are in the economic cycle.
That's obviously not easy as there's always a debate on where we are in the cycle and what's going to happen next. You might think it feels like a subjective decision that should be made by an active manager. But Yoon argued that this decision can be made in a rules-based way, so these adaptive multi-factor ETFs are still passive smart beta funds.