Smart Beta - Learn about a future investment strategy today.

Singapore investors are are very much behind the curve when it comes to better investment products in the market. The aim of this article is to look at this very modern buzzword called Smart Beta and start everyone thinking about how to react when this this new trend arrives in Singapore.

Smart Beta is the next evolution of the ETF. It employs a formula or algorithm to determine the composition of a portfolio and transfer cost savings to the investor.

What Smart Beta tries to achieve is to create a new range of offerings which simulate how a fund manager would manage your money. Fund managers typically invest and diversify your stocks the same way as his benchmark index would be designed, buying a basket of stocks similar to an ETF but then he would vary the composition of his stocks by exploiting well known market anomalies. One example is that by simply holding an equal weighted basket of stocks, the fund manager can perform slightly better than capital-weighted index.

[ This is very similar to an old idea called fundamental indexation. Perhaps a practitioner can advise me on what's the difference between that and Smart Beta. ]

Six strategies have since been packaged in the form low cost ETFs :

a) Liquidity - ETFs which give more weight to liquid stocks.
b) Momentum - ETFs which give more weight to stocks which previously did better.
c) Quality - ETFs which give more weight to more profitable companies such as ROA and accruals.
d) Size - ETFs which exploit the idea that smaller stocks tend to do better in the markets.
e) Value - An ETF which overweighs higher yielding stocks fall into this category.
f) Volatility - An ETF which gives more weight to stocks of lower volatility.

As of now, there are no Smart Beta ETFs in the local stock exchange but understanding this new instrument is useful to us in many ways.

As Smart Beta ETFs fall into 6 strategies, we can reverse engineer each strategy to find out what most fund managers think. Imagine how vulnerable fund managers are one an ETF can be designed to put them out of a job. Within a year or two there might even be ETFs which hold a basket of Smart Beta ETFs which feed economic data into an AI which determines the ETF allocation.

The question I want to ask myself and readers is whether would it be possible to design a around Smart Beta, mapping an allocation to economic situation of a country.

Eg. When the economy turns around after a recession, you should over-weigh Momentum. When a market has peaked, you over-weigh Value.

This exercise should be done now because the rise of Smart Beta is inevitable in Singapore.

Just like an ETF for S-REITS.