For some time now, there’s been a significant change going on in how institutional investors are managing the things I think of as the in-betweens: things like sectors, risk factors or other systematic exposures that are less than asset classes but more than securities. This in-between is the realm of smart beta.
A new study by Russell’s Index group explores asset owner perceptions of smart beta. Alongside details of the trends in consideration and adoption of smart beta strategies is one result that jumps out and, I must admit, rather pleases me. When asked “what is your preferred name to call what the industry has been calling ‘smart beta’?” smart beta was the third most popular choice among North American respondents, gathering just 15% of the votes (that number rises to 35% among European respondents.)
This lack of endorsement of the term is, I would guess, at least in part because managing the many in-betweens is hardly a recent development. Even though the term “smart beta” is new, the idea is anything but. The Russell 1000® and 2000® indexes were launched in 1984, highlighting the large cap/small cap distinction, and the value and growth series three years later. Fama and French’s highly influential “Cross-Section of Expected Stock Returns” was published in 1992. But we can see elements of this thinking even in Benjamin Graham’s writings, now more than 60 years old.
What really is new is the variety and precision of the tools available to investors to monitor and manage these factors. Whether for strategic positioning, for tactical/dynamic positioning, for risk management or for other purposes, investors today have the ability to directly manage exposures in ways that were not possible sixty, thirty or even five years ago. It’s this explosion in the availability of better tools that is the driving force behind the interest in smart beta. Whether the term “smart beta” passes the test of time or we end up calling it something else, these new tools are changing the way portfolios are managed.