The important factors in smart-beta investments strategies

In the current low return environment, clients are putting pressure on fees while still seeking returns above the benchmark. Fund managers have responded with new lower-cost products and investment strategies, including smart-beta.

The rise of ‘smart-beta’

Smart-beta are quantitative based strategies that seek to outperform traditional market cap indexes such as the traditional S&P/ASX Index. Unlike traditional indices, smart-beta strategies aim to tilt to underlying building blocks of share returns such as momentum, volatility, or value – breaking the link with market cap as the criteria for investment. Dan Farmer, IOOF portfolio manager – Australian Equities, says smart-beta strategies aim to provide the best of both active and passive investing.

“This allows a fund to deliver returns above benchmark indices, but thanks to objective, rules-based methodology, at lower costs than a pure active fund,” Dan says.

While smart-beta portfolios can theoretically be built on any fundamental measure, deciding which ones will deliver a premium to traditional benchmark indices can be a little trickier. This is where factor investing can help. Factor investing is a sub-set of fundamental analysis which aims to systematically capture attractive characteristics such as value or momentum and therefore deliver higher returns. While these factors can be diverse, commonly they are: value, size, momentum, low volatility, term and credit.

In the world of factor investing, these factors stand out because indices based on these six measures have historically earned returns in excess of market-cap weighted indices.

Dan says this neither surprising nor a well-kept secret for some factors. “Factors such as value have long been used when constructing share portfolios.”

Other measures are a little more surprising. Higher volatility, for example, is commonly associated with higher returns but less volatile shares have delivered higher returns over the longer term.

Implementing a factor strategy

In October Adviser News we looked at the challenges – and importance – of periodically rebalancing client portfolios. Factor investing, where some fundamental analysis is required, adds another level of complexity to portfolio rebalancing.

Dan says factor investing isn’t a simple buy and hold strategy and it makes sense for advisers to access this strategy through professionally managed funds, such as IOOF MultiSeries.

“Fund managers are doing the hard work by constructing, and rebalancing, both single factor and multi-factor funds,” Dan says. “Advisers can concentrate on asset allocation, which is the main driver of returns in a diversified portfolio.”

Factor investing and risk

Factor investing should be considered in conjunction with a client’s tolerance for risk and volatility. Just like the asset classes they are derived from, factor returns are cyclical and different factors have clear periods of underperformance For example, momentum investing traditionally outperforms in bull markets, whereas low-volatility is a more beneficial approach in flat or declining markets.

”Factor investing can be an important risk mitigation strategy, while keeping fees under control,” Dan says, “at the same time, proactively moving between factors can offer excess returns while maintaining a diversified portfolio.”

“Factor based funds can be used to keep the risk, and cost, in line with the client’s appetite.”

The prospect of lower fees for similar returns to those achieved by fully-active managers is enticing. There are however, many different considerations – from risk to portfolio management, costs and more – when deciding whether factor investing is right for your clients.

For more information, read IOOF portfolio manager – Australian Equities, Dan Farmer’s interview in the November issue of the Financial Planning magazine here.

IOOF MultiSeries is a range of funds that are predominantly actively managed at a lower cost when compared to other active funds. It is suitable for clients seeking a low-cost multi-manager solution that targets a moderate level of outperformance through an efficient blend of active and passive investment strategies and active asset allocation. So if you’re after more, call IOOF Adviser Services on 1800 659 634 or go to

The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.