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Manage Market Risks with Smart-Beta ETFs

etftrends@etftrends.com (ETF Trends)

As the markets slow down from a multi-year bull rally, investors can turn to smart beta exchange traded funds to navigate uneven growth and potential hurdles ahead.

On the recent webcast, J.P. Morgan’s Market Outlook and ETF Strategy for 2016 , Andrew D. Goldberg, Managing Director and Global Market Strategist at J.P. Morgan Funds Management, helped paint the current economic picture. Currently, we are in the 82 month of an economic expansion, compared to the historic average of 46 months. Consumers are in good shape with large balance sheets, low household debt service ratio and rising net worth. Goldberg also pointed out that many analysts are expressing optimism over S&P 500 earnings ahead, with the energy sector returning to positive in the coming months.

However, there are some risks that investors need to keep an eye on. For example, Goldberg argued that political uncertainty is a headwind. Investors should be a little concerned as the party orientation of a sitting president has shown a correlation to market and economic performance – S&P 500 returns and real GDP growth have both been higher during the tenure of a Democratic president.

Related: What’s So Special About Smart Beta ETFs?

Global central banks have implemented low and even negative interest rates, which have made income investing tougher.

Additionally, China’s transition from an export-oriented economic model to domestic consumption has caused some growing pains and a slowing economy.

Consequently, given the risks and uneven growth around the world, Goldberg argues that a smart beta ETF strategy can help investors hone in on areas of strength.

Brad Zucker, Senior Product Manager of Alternatively Weighted Indexes at FTSE Russell, explained that smart- or strategic-beta is a combination of both passive and active styles – the strategies are passive index-based but implement actively managed investment strategies, such as factor screens for quality, size, value, volatility, yield, momentum and illiquidity.

Zucker also pointed out that smart-beta indexing methodologies help diminish exposure to traditional cap-weighting flaws, such as bubbles, risk concentrations and preference for overvalued stocks.

“An approach that redistributes risk coming from regions and sectors reduces exposure to frothy markets,” Jillian DelSignore, Executive Director and Head of ETF Distribution at J.P. Morgan Asset Management, said, warning that market cap-weighted indices can increase weights to securities as prices rise without regard for valuations.

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Alternatively, more financial advisors and investors have turned to smart-beta index ETFs for return enhancement, risk reduction, improved diversification, specific factor exposure, cost savings and income generation, Zucker added.

For example, Philip Blancato, CEO and President of Ladenburg Thalmann Asset Management, added JPMorgan Diversified Return International Equity ETF (JPIN) to his portfolio as a way to capitalize on the ongoing quantitative easing in Europe and Japan, lower relative valuations to domestic equities and ongoing economic recovery. Blancato argued that JPIN’s multi-factor indexing methodology can capture more upside while still protecting against potential downsides through risk weighting and the volatility factor.

Related: Liquidity For Smart Beta ETFs Improves

The underlying index diversify risks that are less likely to be rewarded while overweighting areas that are more likely to be rewarded. The underlying customized FTSE Russell index selects components based on a diversified set of factor characteristics, such as relative valuation, price momentum and quality. The enhanced indexing process would allow the ETFs to exclude expensive, low quality companies with poor momentum, which could help the ETFs diminish drawdowns without sacrificing too much from any potential upside of a market recovery.

Along with JPIN, J.P. Morgan offers a suite of Diversified Return Equity ETFs, including the JPMorgan Diversified Return Emerging Markets Equity ETF (JPEM) , JPMorgan Diversified Return Global Equity ETF (JPGE) , JPMorgan Diversified Return US Equity ETF (JPUS) , JPMorgan Diversified Return Europe Equity ETF (JPEU) , JPMorgan Diversified Return Europe Currency Hedged Equity ETF (JPEH) and JPMorgan Diversified Return International Currency Hedged Equity (JPIH) .

Financial advisors who are interested in learning more about smart beta ETF strategies can watch the webcast here on demand .