Our investment specialist, Philip Bailey, contributed to a recent Interactive Investor article, explaining how smart beta funds can be used in portfolio construction.

Smart beta funds are a relatively new kid on the investment block and are gaining their fair share of attention because they’re quite different to the type of funds we’ve grown used to. Particularly favoured by institutional investors, at the moment they’re still largely undiscovered by retail investors.

So what might make these funds something of interest to you?

High cost managers or low cost trackers?

Not so very long ago, if you wanted a managed fund that was actively run by experts, you’d have to face up to the price tag that came with that. Then, against the backdrop of harsh publicity surrounding highly priced funds that weren’t performing all that well (justifiably in many cases), came low cost tracker funds that were pretty much run by technology, with little or no human involvement. As markets went down, tracker funds ultimately went down and came up for criticism, giving rise to a gap in the market for a different kind of fund.

That fund is the smart beta fund.

Beta background

Beta is the term that’s used to describe the way of measuring the risk profile of a stock. It’s a system used by analysts to make risk analysis more scientific. In a nutshell, beta is the term used to define a stock’s volatility in comparison to the market as a whole. The market is deemed to have a beta of 1.0 and any stock that deviates more than the market over time will have a beta of over 1.0. Stocks that deviate less than the market it will have a beta of less than 1.0.

As you can imagine, any stock that is fluctuating more than the market is of a riskier nature and a stock that fluctuates less, is lower risk. It is normal to expect higher risk funds to produce higher returns than lower risk funds, but of course this isn’t always the case and any investment comes with the usual health warnings.

The Beta opportunity

Smart beta funds are in fact a type of tracking fund but rather than tracking familiar indices, these smart beta funds have their own indices or benchmarks to follow. The main issue with traditional tracker funds was that they tracked the market, no matter in which direction it was headed. Therefore, a tracker was a great vehicle in a rising market, but not so great in a falling one.

Smart beta funds are different because they incorporate both a passive and an active style of fund management, allowing costs to be reduced at the same time as enabling this scientific approach to stock selection and investment, this helping to prevent the downside of traditional tracker funds. Smart beta funds allow for a selective style of fund management that combines the lower cost tracker approach with the higher cost highly active fund management approach. In many ways, these funds offer the best of both worlds. The other main advantage to this sort of fund is its greater predictability.

The only slight downside to smart beta funds right now is that they’re priced slightly higher than a traditional tracker fund, with typical annual costs running about 0.15% above the classic half a percent you’d expect to pay on a tracker.

You can find out more about smart beta funds in which Provisio have contributed to.

Establishing whether or not smart beta funds might be right for you

As with all financial decisions, determining whether or not beta funds may have a place in your investment portfolio is a detailed and in-depth process. Your attitude to risk, your need for liquidity and your existing investments will all impact on whether or not these funds might suitable for you.

At Provisio, our advisors make it their business to look at every aspect of your financial planning before making any recommendations or deciding on the suitability of an investment vehicle. If you’d like to find out if these funds might suit your investment portfolio give Philip Bailey a call on 01462 687337 or email Philip at pbailey@provisio.co.uk