Look to Smart Beta to Perform Over the Long Run

Speed and Endurance: Smart Beta Goes The Distance

There are athletes who train for speed and athletes who train for endurance, and some who manage to conquer both. For investment managers trying to get portfolios to perform over the long haul, there are new ways of investing that allow them to use both in order to see returns.

Amy Kemp, Senior Analyst at Dorsey Wright & Associates , a Nasdaq Company, points out that investing for the long term means shepherding assets through several market cycles. From Dow Jones Industrial Average data she identifies bull and bear markets running roughly every decade over the past 100 years and concludes that a retiree average lifetime of 85 years will hit roughly three of these major bull and bear cycles.

Investing through these cycles will take not one strategy, but several, acting in somewhat of a relay. Kemp draws an analogy to running a race in the Olympic Games. While the world record for the 400-meter dash in an individual race is 43.18 seconds, a record held by American athlete Michael Johnson, the record for running 400 meters the fastest is set by the Jamaican relay team, which ran the same distance and won, but shaved a whole six seconds off of Johnson’s record time.

Putting together a long-term investment portfolio for a smart beta index fund is similar in scope to a relay team. Just as a relay team hands the baton off from one runner to another, a portfolio can switch focus to be at its most powerful at the appropriate instance.

Instead of reacting to short term market noise, smart beta models attempt to identify long term trends and adapt. There’s not a set time limit for each sector to stay inside or outside of the portfolio, as trends can, in some cases, persist for years.

Yes, it’s about having a diversified portfolio but one that makes sense for what is happening to markets and the economy during that period. Smart beta investing is smart shopping. The vagaries of the market are such that the strongest and most promising investment sectors can quickly become unfashionable. The trick is being prepared to move to the next leg of the race with the right strategy in place.

For example, in this past decade and a half, we saw the technology bubble burst, and coming out of that period we saw outperformance in energy stocks. Leading up to 2007, we saw long term strength in the financial and real estate sectors, and this past year (2015), the healthcare sector performed well. The strength within those sectors was of varying durations and exhibits the importance of sector rotation.

A smart beta index fund attempts to adapt to the many twists and turns of the market. Just as the only certainty in the economy is uncertainty, the smart beta index world is uniquely positioned to rotate to areas of strength within the market, as market leadership changes.

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