Strategic Beta Introduction

Being cyclical does mean that there will be periods, sometimes long periods, of underperformance. Value having lagged and underperformed for the best part of the decade came back strongly in 2016. The development of strategic beta funds now allows investors to systematically access the value stocks at a fraction of the cost charged by active managers. For example, iShares Edge MSCI USA Value Factor ETF (listed in the U.S. and various exchanges in Europe) scores stocks on three separate value metrics and applies sector constraints in order to prevent sector biases.

Small Cap
Size is perhaps one of the better-known factors in the investing world. There is evidence that small cap stocks outperform large cap stocks. And there are many theories on this but they all boil down to the fact that small companies are riskier than large companies. And risk is painful. It hurts. In an efficient market, investors should be compensated for accepting greater risk with higher expected returns.

Overall, small companies are less profitable, less liquid and they have less analysts covering them, which also increases their chances of being mispriced. Small caps are also more volatile. While investing in individual small caps may be risky, when you hold an entire portfolio of them, you disperse this risk and increase your chances of picking up the next Amazon at a bargain.

For these reasons, this strategy is not for the faint of heart. Even though small caps are associated with better long-term performance, they can go through years and years of underperformance, making them difficult to stick with sometimes.

What has worked in the past may also not continue working in the future. There are concerns that as liquidity increases and information moves more efficiently, the small cap premium may diminish.

Minimum Volatility
Passive low-volatility strategies have become one of the best performing and most popular strategic beta strategies. In the past three years alone in Europe, passive min vol funds have attracted over €3 billion in net inflows.

Simply put, minimum volatility investing involves selecting a portfolio of low risk stocks. This strategy has rewarded investors with superior risk-adjusted returns compared with cap weighted alternatives.

Common metrics used to determine a low risk stock are standard deviation, downside standard deviation and beta.

It is unsurprising given the defensive nature of minimum volatility investing that these strategies have helped cushion the blow in market downturns, but have also lagged their cap-weighted counterparts in upswings.  Investors should not expect these strategies to generate market-beating returns, but they should offer a smoother ride and outperform most of its peers on a risk-adjusted basis.

Investors in low volatility strategies should be aware that they are making an implicit quality bet – as lower volatility stocks also tend to operate with lower leverage and have more stable earnings growth.

The highly quantitative nature of minimum volatility strategies makes them a perfect fit for the rules based approach of passive investing.

Examples are four of the iShares Edge Min Vol range – which cover World, emerging markets, US large caps and European equities. These funds apply several constraints, such as sector constraints to ensure that investors are not making unintended bets.

Growth
Growth investing is an investment strategy that focuses on companies with a lot of potential to grow in the future and make a lot of money, even if these companies are already expensive.

Technology companies like Apple, Amazon and Google are well-known examples of growth stocks. However, while these companies have been hugely successful, many growth stocks go down in value. Growth stocks are riskier investments than others, certainly riskier than stocks that have been paying dividends for years.

Growth stocks typically don’t pay dividends as they prefer to reinvest the money back into the business to finance further expansion. One way to minimize the impact of that risk on a portfolio is to buy a diversified strategic-beta growth ETF.

Growth stocks have outperformed value stocks in recent years, which many see as an anomaly. In the long run, it is commonly expected for growth stocks to underperform value stocks.