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How To Build A Well Rounded Smart Beta Portfolio

This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Andrew Gogerty, vice president of investment strategies at Boston-based Newfound Research LLC.

Lockheed Martin’s Advanced Development Programs, famously known as Skunk Works, is a think tank for cutting-edge aircraft design. It is noted for the high degree of autonomy given to its engineers.

Despite a focus on innovation, the team adheres to “KISS,” an acronym for “Keep it simple, stupid.” The general philosophy of KISS has been observed in many industries. Albert Einstein once said, “It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience.”

This quote is often paraphrased as “Everything should be made as simple as possible, but no simpler.”

As demand for factor, or “smart beta,” exposure has increased, so has the complexity and number of smart-beta ETF offerings. There are now not only a plethora of single-factor options, but ETFs that look to combine multiple factors into a single portfolio.

Efficiency Philosophy

As the number of alternatives becomes overwhelming, it can be tempting to turn to “throwing spaghetti at the wall to see what sticks” method of portfolio construction. Instead, we recommend that investors use KISS, which is at its core is an efficiency philosophy.

The “stupid” doesn’t refer to intellect; rather, the ability to use simple tools and steps to address even the most complex problems. Building a smart-beta or factor portfolio, means sticking to tools and exposures that are thoughtfully simple in their philosophy and implementation.

It also—and perhaps most importantly—means being able to identify where past risk-adjusted outperformance has come from and to articulate why this outperformance is likely to continue.

In a previous article, we outlined steps for selecting a smart-beta ETF. Our focus here is on building a comprehensive smart-beta portfolio. Newfound’s U.S. Factor Defensive Equity Strategy uses five smart-beta ETF exposures. But general ETF selection is still built around three core ideas:

  • Simplicity in process

  • Consistent backing with academic literature

  • Relatively pure in exposure

Our portfolio includes exposures to value, momentum, low volatility, size, and dividend growth. Below are some of our thoughts and considerations that went into selecting the ETFs for this strategy’s investment universe.


We use the Guggenheim S&P 500 Pure Value ETF (RPV | A-59) to access the value factor. The portfolio is relatively concentrated, with usually about 100 individual holdings. It also weights each stock in proportion to its value characteristics. As a result, we believe this ETF provides one of the purest exposures to the value factor (see our previous article for a deeper dive into the data).


There are only two momentum ETFs that have more than $1 billion in assets: the First Trust Dorsey Wright Focus 5 ETF (FV | C-45) and the iShares Edge MSCI USA Momentum Factor ETF (MTUM | A-69). We prefer to see the performance generated at the stock—rather than industry—level, and include MTUM in our strategy portfolio.

Low Volatility

This factor has certainly been the belle of the ball in smart-beta land, as the anomaly has been applied to domestic and international stocks, markets and regions around the globe. Portfolio construction varies considerably among the different ETF options, so again, you have to know what you own and understand the index methodology.

This exposure is used for risk management in our portfolio, so we prefer a portfolio that takes into account correlations and sector concentrations. As a result, we currently use the iShares Edge MSCI Minimum Volatility USA ETF (USMV | A-69).


The size factor was included in Fama-French’s original three-factor model for decomposing stock market returns, and thus has also been exhaustively studied. We prefer quality small-caps, and currently use the Guggenheim S&P 500 Equal Weight ETF (RSP | A-80). The ETF has the S&P committee’s quality bias, and its larger-cap orientation will inherently tilt the portfolio toward higher-quality stocks, while the equal-weighted methodology will preserve the small-cap bias.

Dividend Growth

We use dividend growth as our quality factor exposure. The term “quality” means the degree of excellence of something. But how do you define excellence? It depends on the situation and outcome you desire. Among ETFs offering exposure to the quality factor, the exact definition—and thus performance—varies greatly.

We chose a track record of consistent dividend growth as our measure of quality due to its simplicity and lengthy track record of success. In particular, we use the ProShares S&P 500 Dividend Aristocrats ETF (NOBL | A-68), since it requires a 25-plus-year history of consistent dividend growth.

The merit of a factor or smart-beta exposure can’t rest solely on the premise of “look how it did/would have done in the past.”

Understanding the key drivers of performance (risk compensation, exploiting investor behavior, etc.) and evaluating your confidence in the ability of those drivers to continue going forward should play a key role in portfolio construction (see our thoughts on that topic here).

We prefer a building-block approach, where we combine individual factor strategies into an overall portfolio. We prefer this approach because of its simplicity. In addition, it allows us to easily understand performance attribution and each exposure’s role in the portfolio going forward. We discussed our preference for a sleeve-based approach in more detail in this article.

At the time of this writing, Newfound Research LLC owned RPV, MTUM, USMV, RSP and NOBL. Newfound is a Boston-based quantitative asset management firm focused on rules-based, outcome-oriented investment strategies. Newfound specializes in tactical asset allocation and risk management solutions. Founded in 2008, Newfound offers a full suite of tactical ETF managed portfolios covering global equity, U.S. small-cap equity, multi-asset income, fixed-income and liquid alternative asset classes. For more information about Newfound Research LLC, call 617-531-9773, visit www.thinknewfound.com or email info@thinknewfound.com. For a list of relevant disclosures, click here.

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