Is smart beta the way to balance your portfolio?

Industry veteran explains how strategy in the ETF emerging markets arena can benefit investors

Is smart beta the way to balance your portfolio?

SmartBeta ETFs are poised to come into their own as investors look to manage portfolio costs and take advantage of emerging markets, according to an industry veteran.

Ahmed Farooq, vice president, ETF business development at Franklin Templeton Investments Canada, addressed the floor at the Radius Exchange Traded Forum yesterday, explaining the strategy behind the firm’s LibertyQT series.

He said EMs were more resilient than ever and less susceptible to volatility, with his firm's ETFs consisting of the largest “steady Eddie” companies and with the selection process split into four areas: quality, which was weighted 50%, value, momentum and low volatility.

Farooq said this approach was not a quick-fix portfolio solution, with the fund often taking about 10 years to outperform benchmarks, albeit with signigicant protection on the downside. He said the four key factors were proven, offering a “smoother” ride for the investor.

He told Wealth Professional that advisors were starting to see the benefits of using SmartBeta with emerging markets: “Before, why would you come out of North America when the US was on this crazy trajectory but now with [President] Trump coming in, there is all these uncertainties and what I'm finding is there are a lot advisors who are perhaps thinking now is the time to look abroad.”

He said that last year’s 27% return on emerging markets had also got people thinking about going all out beta in the US where, as Farooq puts it, things can “change on a dime”. Fully active he argues can be feast or famine so SmartBeta ETFs allow the investor to be somewhere in the middle.

The LibertyQT ETFs are rebalanced twice a year and Farooq highlighted another hot industry topic: the so-called race to the bottom over pricing. The LibertyQT SmartBeta fees start at 25 basis points, with active going up to 30 and the EMs funds capping out at 55. Farooq said having a competitive edge around cost was crucial.

“There is going to be a fee compression that is going to happen with traditional mutual fund companies that are going into ETFs because they are pricing their ETFs very closely to F-class pricing,” he said.

“They don’t want to take away from the margins they already have so they will come into a price that they are comfortable with – maybe five basis points cheaper than the F-class fund. We felt that eventually even that will come down.”

He added that with alpha proving harder to generate, this low-volatility SmartBeta approach will win over many advisors.

He said: “There’s a lack of alpha being generated on the active side and because of the fees, they wanted something in the middle which was quasi-active but not active, and then you kind of get rid of the active manager risk in there.

“That’s not to say there are not good active managers. It’s more about trying to reduce costs in a portfolio. How can I do that? Well, maybe I can take this approach and do without having to worry about all the other nuances that come with active. Or just try to find the better active manager that will do well.”