Inside passives: smart beta

  • Investment Insights
  • 5 minute read

Passives are big business – and in fact now top ~$5 trillion globally.1 To most investors they mean low cost investing, providing a way to invest in hundreds of the world’s best known companies and get the return of the market/index/sector2 (or ‘beta’). Our Close Tactical Select Passive (TSP) fund range fulfills this brief and is growing in popularity.

Investment Managers at Close Brothers Asset Management also recognise that passives can diversify exposure, provide access to markets where we have no direct expertise or facilitate a tactical trade where controlling costs is crucial to improving our clients’ returns. This is why they may be used across services to complement different strategies - an example of expertise being shared across our business.

Performance to make you smart

With our TSP fund range, we also attempt to outperform an index using smart beta. We loosely define this term as any strategy with a strong academic methodology, aiming to isolate certain characteristics of the market and allow investors to broaden their set of asset allocation tools. Funds which try to tilt their exposure towards Value, Growth, Income or Momentum, for example, might all be considered smart beta. In particular, low interest rates prevailing for an exceptionally long time has propelled the growth of income-biased smart beta funds.

One such fund we currently like is the Powershares S&P 500 High Dividend Low Volatility ETF by Invesco. It distills the S&P 500 into a much more concentrated portfolio of just 50 stocks which meet their high-dividend, low-volatility methodology. Another example is the First Trust US Equity Income ETF, whose criteria for inclusion requires a dividend yield 1.5 times the index median and a debt-to-equity ratio of no higher than 90%.

Whilst these ideas focus on stock selection, there are new strategies using derivatives to financially engineer a desired outcome. BMO’s Enhanced Income USA Equity ETF does this through writing call contracts on stocks it owns within the S&P 500 Index: these ‘covered calls’ receive a premium in return for offering the buyer the right to purchase the underlying stocks at a later date and an agreed strike price. It targets enhancing the yield of the index by 2% to 4% p.a.

Have your beta and eat it?

Of course, there is no such thing as a free lunch and the rub here is the cost. These three strategies cost between 0.3% and 0.55% p.a. compared to standard, off-the-shelf trackers which may cost as little as 0.07% p.a.. So the key question we fixate on is; will the addition of a smart beta fund in our portfolios actually deliver the returns and experience we anticipated after the cost of buying and selling it? There are others questions too:

  • Is the methodology proven?
  • In which markets might a strategy not work?
  • How will its inclusion impact the portfolio’s volatility?
  • Are there any unintended consequences of using it instead of something else?

All of these questions require complex and sophisticated scrutiny, monitoring and reporting to ensure we understand the risks created in what is still essentially a passive strategy. We must be able to explain, in forensic detail, the performance of every holding so that we can determine what is adding to or detracting from our numbers.

Expert game - value added

In short, to truly understand smart beta and how it fits into a portfolio which may be passive, active or a blend of the two, you need experts to help you to navigate a fast-moving and ever more complicated segment of the passives market. For the cost of getting it wrong undermines trying to be smart in the first place!


1Citi Research: Riding the Passive Wave, with kind permission 27.02.2019.

2This is a simplified view. In reality, costs, tracking error, replication methodology (physical or synthet¬ic) and replication frequency are among the reasons which market returns may never be 100% as reported by the index being tracked.

Important information
This article is only intended for use by UK investment professionals and should not be distributed to or relied upon by retail clients.  The value of investments will go up and down and clients may get back less money than they invested. Past performance is not a reliable indicator of future returns. The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.


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