Smart-beta managers call out active managers on transparency

Asset managers with smart-beta strategies point to transparency as a primary benefit over active managers when it comes to factor-based investing.

Smart beta — also referred to as strategic beta — is an index-based strategy that, unlike traditional passive management, invests according to factors other than market capitalization, such as valuation, size, momentum, volatility and quality.

Whereas active managers don’t proactively disclose any changes to the factor-based strategies underlying their investment decisions, smart-beta funds offer elevated transparency because they must announce rule changes to investors ahead of time, according to a panel of executives Wednesday at the fifth annual InvestmentNews Alternative Investments Conference in Miami.

“The reason smart-beta has taken the industry by storm is they’ve made [factor investing] transparent,” said Samuel Lau, a member of the investment team at DoubleLine Capital.

Smart-beta products have gained a lot of traction among advisers of late. Sixty-eight percent of advisers using exchange traded funds currently incorporate a smart-beta product in client portfolios, according to a report released this year by FTSE Russell.

The smart-beta ETF product universe has swelled too, according to Morningstar Inc. data. There are 844 smart-beta ETFs on the market, up from 673 a year ago, and assets swelled to $497 billion from $396 billion over the same time period.

“One of the reasons we prefer an index-based approach [for factor investing when compared with active management] is because there’s transparency in the rules,” and that occurs ahead of when a portfolio change takes place, according to Chris Huemmer, senior vice president at FlexShares.

Those disclosures of changes in strategy typically occur 60-90 days beforehand, he said. However, investors in active funds don’t become aware of such underlying alterations until the managers decide to publicly disclose them, Mr. Huemmer said.

Some smart beta products allow investors to receive some “incremental alpha,” and investors get a view into the “secret sauce” that active managers usually guard, Mr. Lau said.

Transparency allows investors to more easily “grade” smart-beta managers on how well they’re tracking an index relative to the factors underlying the portfolio, according to Mr. Huemmer.

“I think [smart beta] is really taking the active management industry by storm,” and will impact active managers’ ability to gather assets in the future, Mr. Lau said.