With the market for smart beta and risk premia products maturing, emphasis is shifting from the selection of individual strategies towards building and maintaining portfolios of these indices.
The number of products in the market is quickly growing as demand increases. Asset manager BlackRock expects the value of smart beta ETF assets alone will more than triple between 2016 and 2020, to reach $1 trillion.
Smart beta and risk premia indices offer tilts towards certain risk factors in order to generate better risk-adjusted returns – or in other words, to control risk, provide excess returns, or both. Factors refer to underlying stock characteristics that drive superior (or inferior) returns. Commonly-targeted risk factors include low volatility, value, size, quality, momentum, and yield.
Increasingly, investors are looking to diversify across factor exposure rather than by asset class.
Since factors are relatively uncorrelated from each other and tend to perform at different times of the market cycle, and under different conditions, blending factors into a single portfolio allows investors to smooth returns and control risk.
One approach is to combine individual factor-based indices into a single multifactor portfolio. Asset managers are increasingly competing in this space, where strategy selection and portfolio management mirrors the traditional stock portfolio model.
In essence, the asset management industry is moving towards a blend of active and passive investing.
