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Special Report: The Big Myth About Smart Beta and Mass Affluent Clients

By Garrett Keyes October 31, 2018

Smart beta can help mass affluent investors drive returns when true active management may be out of their reach. Part 3 of a 5-part Special Report on Smart Beta.

Smart beta has become increasingly important to all types of investors, ranging from the sophisticated to the beginner, over the past 10 years, Doug Regan, CEO of Cresset Wealth Advisors, says. The industry defines smart beta investments as strategies that combine active and passive management properties to drive returns and lower associated risk. And for advisors of mass affluent clients, the ability to pay lower fees than active management while keeping return and risk-mitigating properties makes smart beta a particular draw.

Clients are becoming increasingly wise to how they allocate their fee dollars to capitalize on inefficiencies in the market around active management, Regan says. Smart beta investments present mass affluent clients with an opportunity to gain cost-effective access to efficient markets, he says, and co-author of Wiley’s "Beyond Smart Beta" Martin Raab agrees.

While smart beta makes sense for every investor, it particularly makes sense for clients without a lot of wealth or investing in their 401(k)s, Raab says. Smart beta focuses on minimizing costs and optimizing investment returns, so for lower net worth clients where fee concerns are higher, smart beta may provide them a strong tool. But mass affluent clients using smart beta may need to use different investment vehicles than high net worth investors, experts suggest.

For advisors, the difference in how you use smart beta across client segments is largely concerned with what investment vehicle you choose for the client, Chris Cordaro, CIO of RegentAtlantic, says. For smaller clients, comingled vehicles such as mutual funds work better – particularly in areas like emerging markets or U.S. small cap equities. Cordaro particularly favors mutual funds as the method of delivery for mass affluent clients because advisors often “neglect the bid-ask spread, and with a low volume ETF you can end up paying a lot more than you would by using a mutual fund.”

Doug Regan

At their core, the reasons smart beta can serve mass affluent clients are the same as they are for HNW or UHNW clients – to generate excess returns or reduce risks. By using smart beta for mass affluent clients, advisors can build returns by adding specific sector or company targets to index funds. These targets let advisors select instruments with a higher price to book value, which can help to drive returns and let advisors outperform the market, Cordaro says.

On the opposite end of the spectrum, Genovese Burford & Brothers is looking at using smart beta with emerging market indexes to reduce risk, partner Mike Genovese says. Without smart beta, there are inherent dangers in emerging markets exposure. EM stock indexes often have a heavy weighting to state-owned enterprises – particularly in China. But by using a smart beta approach, such risks can be screened out, Genovese says.

While it’s often difficult to educate sophisticated high net worth clients about smart beta, it can be even more difficult to explain the strategies to mass affluent clients, some experts say. It is vitally important for advisors to take the time to break down smart beta for their mass affluent clients, says Cordaro.

“The worst thing an advisor can do is throw around industry jargon” to their client, he says, and using the term ‘smart beta’ accomplishes just that.

What do smart beta investments mean to high net worth and mass affluent clients?
HNW and UHNW Clients SimilaritiesMass Affluent Clients
Investors with taxable portfolios can gain great relief from using smart betaDefinition of the strategy can be overly complex and full of industry jargon.Mass affluent clients can best use smart beta investments through fund structures such as ETFs and Mutual funds.
Using smart beta in HNW portfolios allow sophisticated investors to better use active managers to target specific investment goals or holes in their portfolios by lowering overall costs and mitigating risks through a balanced portfolio.Malleable in design, smart beta strategies can be used to drive return or lower risk, and provide low fee alternatives to active management.Mutual Funds are particularly valuable tools in smart beta investing for FAs with mass affluent clients to produce an overall diversified portfolio at lower costs, while also having the flexibility to emulate a more sophisticated portfolio

Next: The risks of smart beta.