Smart Beta ETF

Most of us agree that smart beta ETF is stupid. However there are sectors in the investment world that has shown to have long term outperformance to the index. These include small caps, value stocks, equal weight etc.

From the data by William Bernstein it seems like small cap value has shown to give the highest return albeit with the highest volatility. If you have a 30 year+ horizon and can stick to your guns then you are likely to outperform. My question is whether these ETF counts as “smart beta”, and how much outperformance is left when tax considerations and higher fees are involved.

I wanted to see how many people tilt their portfolio to these specific sectors, and any discussion is appreciated. Of course one does not need to tilt their portfolio to these sectors to achieve a good return, but I am interested in the thoughts of those that do.

I guess the next question is whether these tilts need to be global, Australia or US based to achieve enough diversification. I am interested to hear what products you use. I did not include growth as most people already own a cap weighted ETF which comprises mainly of growth companies.

 

I have an exposure to global all size value.

Why? hmmmm good question

The value fund I hold is fairly diversified in its own right and the factor loading over the very long run after costs will most likely return very similar to cap weight. In other words, I expect no negative or positive from it. Of course, I could be wrong it might outperform it might underperform, both are equally likely. So, this paragraph is not a good reason to tilt.

The main reason I tilt is because I’m constantly adding funds to the market.

This graph is Value (VVLU) relative to Cap weight (VGS).

Value factor, like it has for a long time now is still underperforming. I tilt because tilting gives me the opportunity to average into underperforming assets in the short to medium term that I expect to have similar returns to cap weight in the long run.​

Don’t take tilting for granted as an easy path. If it works, it only works because it is hard to stick with. We as humans love immediate positive feedback - All feedback to date from the time I started accumulating value is that I’m a complete Nuckfuckle – should have just brought only cap weighted and not underperformed – In reality this emotional discomfort could last for another decade or more before the strategy pays offs. I have a couple of decades experience in markets to help override emotion with logic and its still not easy.

 

I dont see the value pardon the pun! in factor tilting outside of perhaps super. Cost + Tax efficiency is sub optimal and tilts bring additional concentration risk and introduce behavioral aspects as already raised. I've found the cap weight arguments pretty compelling after looking at this over the years.

 

Call it simplicity, laziness, stage of life or simple intellect, but given there’s no guarantee factors will outperform cap weighting and even if it does the additional cost / tax might negate it in addition to it being yet another holding to administer I choose to avoid holding such things.

Then again I’m on record for liking listed Infrastructure / property where the cost is greater again so a similar argument to above could apply. Though haven’t added any to the portfolio at this stage. One could argue that it’s all about correlation, one zigs whilst the other zags. But I don’t need the capital so there goes that argument.

Which now when I think about it, it really comes down to one thing ie I’m overdue for a drink after nearly two weeks of abstinance.

 

Your survey should include a response for no sector tilt.

 

Yes I regret that now but can’t change it...

 

That was my first thought but I then reasoned it was aimed at eliminating old farts like me.

 

Argh I wish I could edit the polls but alas I get the feeling most people don’t factor tilt anyway.

 

I was eliminated as soon as I saw the word "Smart" irrespective of age.

 

LOL, yeah add that to my other reason.

 

Hi @dunno , do you think that since long term data shows outperformance in the value factor, that gap is now quickly closing as more people are now investing in that area? Many people factor tilt in value nowadays and I can’t see the outperformance data going unnoticed by the big fundies. Perhaps that is why growth has run wild for the past decade?

 

Hi @blob2004

I think there is a little something in the value factor because it buys ugly and doesn’t seek out instant gratification which runs against human nature. Sure, it can be arbitraged by computer systems, that is what Smart Beta ETF’s do – But can enough “Humans” buy and hold these ETF’s for long enough to eliminate the factor return? This factor will have long periods of underperformance with abrupt reversals to the upside where the entries won’t be big enough.

Conversely, I think momentum and quality as factors will probably over the long term turn out to be slightly detrimental – human nature is to be attracted to immediate confirmation via momentum and pretty via quality. These types of factors will have long periods of outperformance but have abrupt reversals to the down side where the exits won’t be big enough.

But I stress whilst value might have some underlying psychology to sustain its slight long-term outperformance, My Assumption is the outperformance will be neutralised by extra holding and transaction costs.

Summary – I expect roughly the same NET long term return from Value factor as I do Capital Weighted.

I hold Value because of a portfolio perspective and particularly because that portfolio is in accumulation.

With a static allocation to both Value and Capital weighted, I effectively buy more of which ever one is underperforming and less of the one outperforming. It’s a “valuation” (not to be confused with value factor) overlay automatically driven by the static asset allocations. If both value factor and capital do return the same over the long run, I will have a better return because I will have brought cheaper than average. If value outperforms that will be a bonus and if it underperforms then any of the above valuation overlay will be negated and may even go negative – but the is no extra return without extra risk.

If I have lost you with the above paragraph – sorry. You could research rebalancing to get some more insight. I’m not the hugest fan of rebalancing, if you have to sell to rebalance or one asset (like bonds) returns much less – The drag soon wipes out the benefit. BUT where you can rebalance with flows ‘aka’ buy the underperforming and the expected long term returns are similar then there is something in it.

I actually started using International Property and Infrastructure to harvest this portfolio rebalancing effect but changed to Value Factor when VVLU came along because I think equity sits above property & Infrastructure for risk premium and the VVLU ETF is well diversified (industry sectors/countries/size) in its own right.

hmmmm. really have to learn the art of one line answers, sorry to have probably confussed with long winded dribble again.

 

Thank you @dunno that is very informative. Not confusing at all and I think you have explained it very well. I think that is a great strategy especially if the value tilt is in Super to minimise CGT. I think Bernstein recommends most factor tilts to be in a tax sheltered portfolio.

Still an area I am pondering about but will probably add emerging markets first before any tilt is considered.