Smart beta on steroids: Why advisors should consider multi-factor funds

Plenty of new investment products have proliferated over the past few years, and experts say advisors would do well to consider some of them.

One is an advanced form of smart-beta investing.

“Smart beta can be used to avoid parts of the market you believe are overvalued and to gain exposure to parts that are undervalued,” says Michael Sheldon, executive director and chief investment officer for RDM Financial Group/HighTower Advisors in Westport, Connecticut. “They can be used to avoid single-stock risk and to provide more market exposure.”

Multi-factor funds are the advanced form of smart beta recommended by Karim Ahamed, a partner and investment advisor at HPM Partners in Chicago.

These funds have grown out of single-factor funds, which tilt toward stocks with a desired characteristic, such as low valuation, small capitalization or low volatility. Multi-factor funds combine some of these factors.

“We’re seeing that pick up steam,” Ahamed says. “The strategy has proven itself over multiple market cycles.”

The idea is that choosing stocks with different characteristics will allow funds to perform well in all market conditions, lifting risk-adjusted returns.

HPM Partners likes funds that focus on stocks with strong momentum, small caps, low valuations and strong quality in terms of earnings and balance sheets. ‘

The quality stocks tend to thrive when market conditions deteriorate, Ahamed says.

“If you use only a single-factor strategy, it’s only going to work during some periods,” he said. “Unless you’re prepared for volatility and underperformance, a single-factor strategy may not be best.”

As for other new investment products, Sheldon mentions liquid alternative mutual funds.

These mutual funds often have strategies similar to hedge funds but without the onerous fees and income requirements. And unlike hedge funds, they can be trade them daily.

“They can be used to help mute volatility and provide diversification,” Sheldon says. “They can help increase risk-adjusted returns.”

RDM Financial Group/HighTower Advisors' clients invest in managed futures funds, long-short equity funds, gold funds multi-manager/multi-asset fund and funds that use options to protect against declines in the stock market.

Advisors must do their research carefully on these funds, given their unique holdings.

“You need to be aware of what you’re investing in,” Sheldon says.

This story is part of a 30-30 series on savvy ideas on modernizing your practice.

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