3 Charts: Why Multi-Factor Smart Beta May Be a Better Buy and Hold


Our 2016 Mid-Year ETF & Investment Outlook forecasts an environment marked by low returns, low yields and heightened volatility. From an investment standpoint, we believe muted expected returns in equities mean investors need to get “more from their core” than from simply buying the S&P 500® Index. My belief is that investors should ensure they have a strong portfolio foundation and consider constructing a better buy-and-hold equity core to navigate today’s market.

One approach to getting more from the core is by using smart beta strategies to seek out factors—such as low volatility, value or quality—that have historically outperformed market cap-weighted indices in the long term.

In an earlier post, I discussed the different types of smart beta factors that exist and how investors may seek to capture them. For this post, I’d like to walk through the role a diversified multi-factor approach may play in allowing investors to get more from their core. To do this, I’ll use three real world examples that demonstrate how implementing a blended factor approach using the SPDR® MSCI World StrategicFactors ETF [QWLD] helped cushion investors from recent episodes of severe market volatility.

1. Markets roll over after a devaluation of the yuan 


Last summer, concerns over the strength of the Chinese growth engine began to ripple through the market, ultimately culminating in the People’s Bank of China announcing a surprise devaluation of the yuan. When news of the currency devaluation broke, markets went into a tailspin and volatility increased. As shown in the chart below, QWLD’s diversified factor exposure mitigated some of the downward spiral in equity levels compared with its benchmark MSCI World Index.

StrategicFactors - Yuan Devaluation


Source: Bloomberg Finance, L.P.

2. The Federal Reserve makes a move and markets move lower

After nearly a decade of zero interest rate policies, the Federal Reserve hiked rates by 25 basis points at the end of 2015, and the S&P 500 Index went on to kick off 2016 with its worst first-week performance ever. The sell-off eventually resulted in a 12% decline in the MSCI World Index.1

Once again, the following chart demonstrates how taking a diversified factor exposure for the core of a portfolio may have been beneficial to helping an investor weather the ensuing market declines. 

StrategicFactors - Rate Hike Reaction

Source: Bloomberg Finance, L.P.


3. Brexit stage left 

At the start of June the odds of a Brexit were less than 30%, but as the rhetoric intensified closer to the voting, the odds increased that Britain would vote to leave the European Union (EU). However, global financial markets still woke to a shock on Friday, June 24th, after learning that the United Kingdom (UK) voted in favor of Brexit. While it was a closely contended race, the global equity markets had rallied leading into the referendum vote, betting that Britons would vote in favor of remaining in the EU.

The chart below illustrates how a fund like QWLD could have helped an investor navigate the financial storm that swept through global markets after the Brexit vote. 

StrategicFactors - brexit


Source: Bloomberg Finance, L.P.

Seek out better buy and holds 

In the back half of 2016, investors potentially face more episodes of market volatility, from slowing global growth concerns, tensions in the Middle East and a contentious US presidential election.

Add to that a market environment with muted return expectations, and it is important for investors to seek more from their core. Utilizing smart beta exposures, particularly those that exhibit balance and diversification, may prove beneficial.

The SPDR StrategicFactors suite seeks to track indices that blend low volatility, quality and value exposures together in a single strategy. The combination of one risk-based factor aimed at reducing absolute risk levels (low volatility) with two return-based factors (value, which is cyclical, and quality, which is defensive) creates a balanced, diversified exposure that may provide a better buy-and-hold core exposure than traditional market cap-weighted strategies, assisting investors with constructing portfolios that are better suited for today’s equity market conditions.

Definitions

CBOE S&P 500 Volatility Index
This index is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.

Market cap-weighted indices
A type of market index whose individual components are weighted according to their market capitalization, so that larger components carry a larger percentage weighting. 

MSCI World Index 
The MSCI World Index is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries. 

S&P 500 Index
The S&P 500, or the Standard & Poor’s 500, is an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices.

Smart Beta 
Smart beta is a set of rules-based index investment strategies that are alternatives to first-generation market capitalization indices. Smart beta indices isolate particular “factors”—small size, value, high yield, low volatility, quality and momentum—and are designed to outperform cap-weighted indices.

1Bloomberg Finance L.P., as of 2/11/2016



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