Smart Beta Pursuing Alpha®
“Smart beta” is often used synonymously with factor investing. The purpose of investing in factors is to capture additional return over an index over time. However, individual factors can come in and go out of favor. Owning one or a few factors that happen to be out of favor will harm performance rather than help it. And owning all (six) of the most commonly used equity factors means you are investing in the broad equity market subjecting you to the same downside risk, and allowing the “out of favor” factors to detract from potential excess returns.This is why we believe smart beta by itself is not so smart!
You must have a process in place to manage factors effectively, and most importantly, has the defensive component desired by most investors.
"Factor" defined:
A factor can be defined as a common attribute for a group of securities that can drive returns in different phases of the economic and market cycle.
Examples of factors include momentum, stocks in a longer-term uptrend that would be expected to continue; or size, stocks of smaller companies that can drive excess returns at times versus larger companies.
BCM’s Paradigm Process
Risk-weighting factors to seek growth, combined with a defensive approach.
Using a set of quantitative models, the system examines patterns in investor behavior that may induce a “paradigm shift” or a change in market environment for individual factors. The ETFs used represent the six widely recognized equity factors. Here are the key steps:
Are we in a “normal” or “volatile” period? The process begins by identifying if each factor ETF is in a “normal” or “volatile” market.
When a Factor ETF is determined to be in a “normal” period. The ETFs that are considered to be in a “normal” market are selected and risk-weighted (allocate more or less based on current risk) according to current market conditions.
When a Factor ETF is determined to be in a “volatile” period. The ETFs considered to be in a “volatile” period are excluded from the portfolio.
Gets defensive by allocating to a cash substitute. In addition to excluding “volatile” (or out of favor) factors from the portfolio, the strategy can move to partial or 100% cash substitute allocation based on the model’s output.
BCM Paradigm Strategies
BCM Paradigm U.S. Factor Selection
100% U.S. Equity portfolio investing in the six most widely recognized factors of size, quality, dividend, value, momentum and volatility.
Designed for investors who are seeking to employ smart beta but need a rules-based process to risk-weight factors and provide defensive capabilities.
BCM Paradigm U.S. Factor 80/20
80% Equity/20% Fixed Income portfolio investing up to 80% in U.S. Factor Equity (BCM Paradigm U.S. Factor Selection) and 20% in High Quality Fixed Income.
Designed for investors seeking a diversified, smart beta solution with lower volatility and for whom 100% equity is not appropriate.
BCM Paradigm U.S. Factor 65/35
65% Equity/35% Fixed Income portfolio investing up to 65% in U.S. Factor Equity (BCM Paradigm U.S. Factor Selection) and 35% in High Quality Fixed Income.
Designed for investors seeking a diversified, smart beta solution with balanced growth and lower volatility.
Fit within a client account:
Designed to be a full or partial replacement of core (strategic) equity exposure, or a total portfolio solution that seeks to provide excess return and defensive measures.
Setting expectations:
Expect ordinary stock (and bond) market movement, but the strategies will seek to avoid large drawdowns when the markets enter longer or more severe periods of duress.
Six Industry Recognized Factors
BCM’s smart beta strategies use factor or multi-factor ETFs, so we wanted to give you a quick definition of the six most commonly used factors in our industry.
While over 400 “factors” have been observed over decades of research, there are six that have been identified as adding material additional return over a long term investment period. These six factors have been adopted by the industry and are the most widely recognized to date. When you hear “factor” investing, typically these six factors are being referenced:
Momentum (positive)
Stocks with upward price trend and stronger past performance.
Value (inexpensive)
Stocks that are relatively inexpensive or have low prices relative to their fundamental value.
Quality (high)
Stocks with low debt, stable earnings growth and corporate governance.
Volatility (low)
Historically less risky stocks with lower than average volatility or beta.
Size (small capitalization)
Stocks of smaller companies with relatively higher growth potential.
Yield (high dividend)
Stocks with higher than average dividend yields.
Adapt Actively
Over time, natural environments will unavoidably change as seasons, resources and climate conditions change. Whether it’s due to an unexpected event or a gradual shift, environments and those individuals living in them learn to adapt to unstable periods in order to survive.
Investors and the markets behave in a similar way. The BCM Smart Beta strategies follow the premise that volatility is driven by human behavior, and that investors are loss averse rather than risk averse. Certain human behaviors, including panic, tend to repeat over time and can become useful investment signals. These strategies are built on this notion that investor behavior can trigger a paradigm shift in market volatility, and seeks to adapt to these changes in market environments.
Is your investment manager adapting to market changes?
"Smart beta by Itself is Not So Smart"
Want to know if you can access BCM’s strategies?
We are available through many TAMPs, and to hundreds of broker dealers and RIAs. We can help guide you in the right direction.
Fill out this quick form and we will get back to you with the best method to access these smart beta strategies, or any of our other strategies that may be available to you.
Or call our consultants at (844) 401-7699.