Smart Beta ETFs: The "Dream Diet" for Your Portfolio

Smart Beta ETFs: The "Dream Diet" for Your Portfolio

If you’ve ever gone on a weight-loss diet, you’re well acquainted with trying to balance the need for fewer calories with the desire for great taste. If your diet was (or is) a strict one, you probably found yourself dreaming about the day when, after reaching your goal, you could finally dig into a nice, juicy burger or that carton of Haagen Dazs once again—guilt free. Unless you’re a big fan of kale salads (of which I am most certainly not!), the reality is that the satisfying taste that goes hand in hand with bad fats and unhealthy sugars is generally off limits for anyone hoping to trim their waistline. If only there was a dream diet that could do it all, delivering the right amount of calories each day to meet your goals, as well as great flavor to keep your taste buds happy too!

The good news is that, at least when it comes to your investment portfolio, that dream diet may be within reach with the help of Smart Beta ETFs.


Just as most diets include a variety of food groups, most portfolios include a variety of asset classes. But while the healthiest diets exclude most of those flavorful sugars and fats, Smart Beta solutions deliver the investors’ equivalent of a dream diet, including lower-calorie options that taste great too. How? By bringing together high-yield and low-volatility, a Smart Beta ETF can help hedge risk while simultaneously driving up total returns within your portfolio—giving you the freedom to eat the one thing that you’ve always been told not to eat: your risk-adjusted returns.

What’s powerful about Smart Beta is that it allows investors to target very specific factors to create an ideal portfolio based on a given asset allocation. Want to boost the number of value stocks in your portfolio? A Smart Beta ETF can do the trick. Need to reduce the risk in your core portfolio? A Fixed Income ETF may be just what you’re looking for. But in addition to helping you achieve the ideal asset allocation, Smart Beta ETFs can also be used strategically to create a “dream diet” that gives investors the best of both worlds: the same returns (you don’t have to give up taste) with lower risk (with fewer calories).

For some investors, however, making that particular leap might require letting go of some old rules.

We’ve all heard the old adage “you can’t eat risk-adjusted returns.” It’s a rule that many investors consider a golden one. But while burning more calories than you take in is a sure-fire way to help you lose weight, not eating risk-adjusted returns is a rule that can—and perhaps should—be broken.

Risk-adjusted returns, of course, are returns in a given period compared to a given amount of risk, often measured by the standard deviation of returns. Advocates of not “eating” risk-adjusted returns argue that even if you have high risk-adjusted returns, your overall portfolio return may still be lower so you have less “eatable” returns to consume—or reinvest. And if you do “eat” your risk-adjusted returns, you’re eating into your portfolio and potentially threatening your long-term success.

It makes sense, but what the theory fails to consider is how the risk-adjusted returns of different investments can work together. Risk, of course, is a key factor in any portfolio, and understanding how much risk an investment has taken during a given time period to deliver that return is vital. Why? Because the more the risk, the less the returns are worth—whether those returns are relative or absolute. That means that what you’re able to consume changes altogether.

So is it ok to “eat” risk-adjusted returns? Yes, it might be. But only if a risk-adjusted return can be achieved that delivers greater overall return than risk. A Smart Beta ETF that focuses on high-yield and low-volatility can help make it happen. Here’s how.

Since low volatility is directly related to risk, one of the most effective ways to reduce risk is to seek low-volatility investments. Using a Smart Beta ETF that tracks the price and yield performance of the S&P U.S. High Yield Low Volatility Corporate Bond Index, it’s possible to tilt a portfolio toward low volatility. And because lower volatility tends to lower risk by more than it lowers return, you now have the freedom to seek out higher risk/higher return asset classes—which are precisely the assets that can help drive up the total return of the portfolio. Think of it as a hedging strategy that targets risk itself to help increase the risk-adjusted returns within the portfolio.

The result: for the same level of risk, you have more to “eat”—either to reinvest to continue to grow the portfolio, or to fund retirement income.

If it sounds a lot like having your cake and eating it too, it is. And while using a high-yield, low-volatility Smart Beta ETF may not make that kale salad taste any better, if your goal is to find a smarter way to invest for the future, it just may be the icing on the cake you’ve been looking for.

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IndexIQ® is the indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC. Sal Bruno is a registered representative of NYLIFE Distributors LLC.

Disclosure:

The information and opinions herein are for general information use only. The opinions reflect those of the writers but not necessarily those of New York Life Investment Management LLC (NYLIM). NYLIM does not guarantee their accuracy or completeness, nor does New York Life Investment Management LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sale of any security or as personalized investment advice.

All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. 
Salvatore Bruno
Building Smarter Portfolios
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Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Prior to joining IndexIQ, ... Click for full bio

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