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Smart Beta ETFs to Diversify Portfolio Risks

editor@etftrends.com (ETF Trends)

Investors enhance returns by accessing time-tested, actively managed investment styles in a cheap exchange traded fund investment vehicle through the new breed of smart beta strategies that follow rules-based indexing methodologies.

"The return premiums expected from smart beta are grounded in investor biases which are systematic in nature, as opposed to unsystematic misjudgments of a stock’s fair value," Mike LaBella, Portfolio Manager at Legg Mason investment affiliate QS Investors, said in a note.

For example, LaBella pointed out that value stocks have outperformed growth stocks over the long-term, with some attributing this as the result of overly confident investors being too optimistic about companies’ growth prospects. Meanwhile, defensive stocks have historically outperformed the market on a risk-adjusted basis, which may attributed to investors being drawn to betting on big payoffs, causing growth and risky stocks to be overvalued in capitalization-weighted indices.

As a way to provide a better play on value or improve risk-adjusted returns, investors may consider smart beta plays like the Legg Mason Low-Volatility High-Dividend ETF (LVHD). The low volatility high dividend ETF should help investors who are seeking new sources of yield in a changing market environment. The funds focus on companies with relatively high yield and low price and earnings volatility, and the funds also target profitable companies.

Additionally, through a partnership with QS Investors, the The Legg Mason US Diversified Core ETF (UDBI) takes a macro, top-down approach that helps balance risk to deliver broad market exposure through QS Investors’ proprietary Diversification Based Investing (DBI) rules-based methodology. Through the DBI approach, the group of global stock ETFs should exhibit low correlation of excess return to active stock managers and traditional market cap-weighted indices. The DBI methodology also helps diminish concentration risk within country and sector exposures.

Furthermore, the bias for outperforming U.S. stocks may also limit an investors overall investment diversification outlook.

"Excessive enthusiasm for fashionable market segments is not the only cause of poorly diversified indices; U.S. stocks often are overrepresented in capitalization-weighted indices, despite their share of the world economy," LaBella added.

For international exposure, investors can also consider the Legg Mason International Low Volatility High Dividend ETF (LVHI) , Legg Mason Emerging Markets Low Volatility High Dividend ETF (LVHE) , Legg Mason Developed Ex-US Diversified Core ETF (DDBI) and Legg Mason Emerging Markets Diversified Core ETF (EDBI) to access broad global markets.

"When implemented well, smart beta ETFs can tactically enhance overall portfolio performance while providing real diversification. They should be used to achieve specific, targeted investment goals," LaBella said.

For more on smart beta ETFs, please visit our Smart Beta Channel.