Top 5 smart beta FAQs

Much has been written about smart beta strategies, and it can get confusing for investors. Answers to these frequently asked questions here could help.

Since my first smart beta blog post in 2014, assets in those strategies have grown exponentially (Source: BlackRock Global Business Intelligence) as investors catch on to smart beta’s potential to enhance returns and reduce risk. But sometimes all the information out there can be overwhelming. To help investors cut through the noise, we are answering some frequently asked questions regarding smart beta.

Why use smart beta in a portfolio?

Traditional active and index funds can help investors achieve their financial goals, but they don’t have to be the only solutions. Smart beta strategies capture the power of factors—broad and historically rewarded drivers of returns such as value (buying cheap) and momentum (trending upward)—to seek higher returns or lower risk. Long embedded within leading active fund managers, factors can now be accessed through cost effective and efficient smart beta exchange-traded funds (ETFs).

What type of strategies are available?

We think about the category in two broad areas:

Single-factor strategies seek to capture individually rewarded style factors. Value, size, quality and momentum strategies can help investors outperform the market, while minimum volatility strategies seek to reduce risk. Because the performance of each factor may vary in different economic cycles, single-factor strategies can be used to express tactical portfolio tilts.

Multifactor strategies combine factors into one holistic, broadly diversified strategy that can potentially outperform the broad market.

Where does smart beta fit with my other investments?

I’m often asked about where to add smart beta strategies. Should they replace or complement traditional index or active strategies? The answer will depend on an investor’s goals and circumstances.

I’ve seen investors replace traditional index allocations with smart beta strategies in seeking to improve returns, reduce risk or enhance diversification relative to market-cap-weighted indexes.

Some investors use smart beta strategies to replace active strategies in seeking to reduce the number of holdings and related costs, as well as to help improve the consistency of performance.

Other investors holding a combination of active strategies and traditional index strategies opt to complement with smart beta, which may help to reduce risk and costs, while improving return potential.

How do I get started with smart beta?

An easy way to add smart beta to a portfolio is through a multifactor strategy. Depending on the market environment, one factor may zig while the others zag. Value, momentum, quality and size have historically low return correlations, so a multifactor smart beta portfolio can potentially benefit in a variety of market conditions and may lead to more consistent long-term results.

Some investors prefer to add smart beta strategies that target one factor as a way to complement existing portfolio holdings. Single-factor ETFs can be used tactically to express views. Take quality, which can be used tactically late in the economic cycle when earnings are typically deteriorating and financial healthy stocks tend to be in particular favor.

Single-factor strategies may also enhance diversification. In a portfolio tilted toward high-growth stocks with less stable balance sheets, a quality factor ETF can be used to seek achieve diversified exposure to financially healthy stocks.

Whether a single- or multifactor approach, there are many different ways to implement smart beta strategies and bring to life the intuitive and longstanding investment ideas that have historically driven performance.

How should I choose a smart beta strategy?

Not all smart beta strategies are created equal. Even among strategies that target the same factor, outcomes can differ substantially due to varying methodologies and portfolio construction rules. We find that setting clear objectives helps sort through the many options: are you seeking outperformance or risk reduction, and what factor exposures will drive those results? The best forms of smart beta are deliberate and transparent in the exposures they deliver, making it easy for investors to determine what’s under the hood.

Perhaps more critical is picking the right provider. Smart beta managers should be investment partners with expertise in implementation, including a critical evaluation of risk, return and costs. Most smart beta strategies have higher turnover than traditional market cap-weighted indexes, and slightly less advantageous liquidity. Without a skilled portfolio management team in place, transaction costs and tracking error may quickly begin to erode the potential benefits of a smart beta strategy.

Have more questions?

Ask away in the comments below and I’ll try to answer them in my upcoming posts.   Investors looking to access smart beta strategies for U.S. equities may want to consider iShares Edge MSCI USA Value Factor ETF (VLUE), iShares Edge MSCI USA Momentum Factor ETF (MTUM), iShares Edge MSCI USA Quality Factor ETF (QUAL), iShares Edge MSCI USA Size Factor ETF (SIZE) and iShares Edge MSCI Min Vol USA ETF (USMV).

Sara Shores is the Head of Strategy for BlackRock’s Factor-Based Investments and a regular contributor to The Blog.

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses. The iShares Minimum Volatility ETFs may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

Diversification and asset allocation may not protect against market risk or loss of principal. Buying and selling shares of ETFs will result in brokerage commissions.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc., nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with MSCI Inc.

©2017 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

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