Citywire Wealth Manager: "Fahd Rachidy, one of the designers of EDHEC’s ‘Smart Beta 2.0’, discusses how the concept works and how it can be applied to portfolios."

Citywire Wealth Manager 12/06/2013

"(…) How does ‘Smart Beta’ 2.0 work?

The idea is initially a critique and an improvement on the first range of smart beta indices, which were designed and based on a bundle of embedded risks. If you take a fundamental or minimum volatility approach, for example, the way they are designed is the index provider chooses the parameters and risk they want to be exposed to. Investors should know the risks they are taking when they choose an index. If it’s an index with a small cap bias, for example, the risks should be well documented and the contribution to performance from those risks should be obvious. Smart Beta 2.0 deals with those issues by giving investors full control of their smart beta investment, so they can choose their own risk factors. It is a choice the investor should make, not the provider. For example, if you want smaller companies or a value bias, you can select your own universe of stocks and the weighting scheme. If you were to use Smart Beta 1.0 for minimum volatility exposure, you have a strong concentration of defensive stocks. You could argue outperformance is not from the minimum volatility but actually the large sector bet, because utilities and other defensives will outperform. So in order to gain pure minimum volatility exposure, you can control the factors. Investors can control sector constraints, geographical exposure, stock selection and weighting schemes, as well as tracking error. (…)"

How can investors gain access to these tailor-made strategies?
We have a range of 2,500 smart beta indices, covering all markets, from developed to emerging markets, but only in equities. We are not there to tell investors we can build 2,500 indices; these are the result of choices investors have made and they are pre-calculated. So if you are looking to buy the US universe of stocks and invest in an equal weighted index with tracking error control, then this index will be one of the 2,500 indices we have pre-prepared. If you want an investible product, for example, and you are an asset manager, you can do it yourself. We give you access to the information and the data to replicate the index. If you are a private wealth manager and you cannot replicate it, you can ask an asset manager to do it. We already have investors replicating some of these benchmarks. "(…)