BlackRock: The Rise of Strategic Beta

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I came across an interesting post on BlackRock’s blog about the sudden surge of money flowing into “Strategic Beta” ETFs (“Exchange Traded Funds”) in 2013.

Market-Cap

The author, Dodd Kittsley, notes that last year was a banner year for this type of investment, with over $65B invested. Kittsley goes on the describe what is meant by the term itself:

Before discussing the flows, let’s first explore what we mean by “strategic beta”. While there is no single definition for strategic beta ETFs, it can most easily be defined as investments based on indexes that are not market-cap weighted. Unlike traditional market-cap weighted index funds, strategic beta equity funds hold a basket of stocks that are selected and weighted by characteristics other than company size. For example, one strategic beta fund may focus on high dividends while others may emphasize low volatility, momentum or quality. The objective of strategic beta is to improve performance by passively tracking an index that is not based on market-cap weighting. In other words, strategic beta is an enhanced form of passive investing.

Traditionally, tracking such targeted market exposure was only feasible through actively-managed funds pursuing alpha. Not anymore.

Assuming for a moment that these funds are still “passive” investments (though some economists would argue that there is no such thing), some economists might take issue with the claim that they are really “enhanced.” After all, the reason most investors buy ETFs is to track an index and not an individual equity. Most major indexes are market-cap weighted, in an attempt to have a basket of stocks reflect the risk-reward ratio of the overall market. One would think that as soon as any ETF moves away from what might be called a “market-neutral” strategy — in search of higher than market-average dividend yield or lower volatility (two of the most popular kinds of strategic beta ETFs) — it is  lowering its overall market tracking function.

These new kind of ETFs are certainly enhanced with respect to a given criteria but are they enhanced with respect to their traditional risk-reward optimization function? It’s an interesting question, and I will write further on this topic in the future.

In the meantime, you can read more on about strategic beta ETF’s here:

http://www.blackrockblog.com/2014/01/15/strategic-beta/

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