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Why You Need To Understand Smart Beta Before You Invest

Posted on: 15.09.2017

I was having a pool day, you know drinking & doing dumb stuff,  this past weekend with my some friends of mine, and my friend Patrick told me he had recently made an investment into an ETF called “spider”.  I wasn’t familiar with spider, so my spidey senses quickly led me SPY the S&P 500 ETF.  I said asked him that’s what he was talking about and he said “yes”.  Now we were on the same page.

Patrick is a pretty sharp guy, and a very successful real estate investor, but I got the feeling his stock market knowledge was limited, so I asked him if he knew what the fund invested in.  He said “yea, the 500 biggest companies in the US”.  I hit him back with “the biggest by what measure?”  He gave a puzzled look and said “sales?”  “profits?”  Market capitalization wasn’t even on his mind.  Turns out, Patrick was invested in something he knew nothing about because he heard that the S&P 500 was a “good investment”.  Patrick’s case is likely the general rule, not the exception.

Know What You’re Investing In

Understanding what you’re invested in is key to being a successful investor.  It prevents you from being taken advantage of.  It prevents you from moving it to or out of, investments at the best time.  It helps you get some sleep at night.

Market capitalization weighting and passive investing is among the simplest form of investing strategies to understand and the majority of investors don’t understand it.  With all the marketing hype around Smart Beta, and the radically varying strategies (and shit) lumped into the Smart Beta category, I can’t even imagine how many investors get roped into Smart Beta funds that they know nothing absolutely about.

Smart Beta Is Not All Equal

Lets look at this in Smart Beta terms.  First, consider two value funds; Vanguard’s Value ETF (VTV), and ValueShares U.S Quantitative (QVAL).  Both look to value based fundamentals of US equities for a holding selection, but other than that they are radically different.  An investor who jumps into QVAL, and compares it to VTV, or worse the S&P 500, is going to get a little uncomfortable and will probably doing something dumb, when Qval zigs (down) while VTV zags (up).  An investor who understands the methodology of QVAL, will probably hold, or buy more.  Consider an investor who hates drawdowns; he/she would know to stay out of Smart Beta Value funds if educated as they tend to draw down further than the market.  An uneducated investor might be wowed by the 10 year return and give it a shot, only to sell at the bottom.

Value as a factor falls harder and further than the market.

Value as a factor falls harder and further than the market.

Not only that but Smart Beta Factors tend to have different periods of over and under performance.  In other words, when one factor is doing well, another factor isn’t.  For the last few years its been the value factor under-performing.  An investor holding a value fund, without understanding the value factor, or the methodology of the fund would likely be very disappointed.

The bottom line, know what Smart Beta strategies you are invested in.  It will keep you from making poor decisions, paying fees that are too high, and help you sleep when your portfolio is going down.  Smart Beta is complex, but fortunately you’re found RealSmartBeta.com.

Corey Philip

Corey Philip is the founder of RealSmartBeta.com. His focus is on expanding investor knowledge of Smart Beta ETFs and quantitative investing. Learn more about Corey in the 'ABOUT' section of this website.

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