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By DailyAlts Staff What do most potential investors think about smart beta? In Goldman Sachs’ (NYSE: GS ) experience, they don’t – only a handful of investors have any idea what “smart beta” is, and most are confused by the distinction between “active” and “passive” investing. For this reason, Goldman Sachs thinks advisors need to serve up “plain talk” in explaining smart beta to their clients, and the firm shares ideas of how to accomplish this in the October 2015 edition of its Strategic Advisory Solutions white paper series. What Smart Beta Isn’t Goldman Sachs defines “smart beta” as referring to “rules-based investment strategies which seek to outperform a traditional market index or reduce risk versus that index,” but the firm admits that this definition is overly “technical” – and therein lies the challenge. Advisors are tempted to define smart beta by what it isn’t – i.e., cap-weighted. But in Goldman’s focus groups, a surprisingly low number of investors understood what “cap-weighted” even meant. Most were happy with their index ETFs, and when asked how ETFs could be improved, Goldman was generally met with silence. Thus, the “market-weight critique” – wherein advisors explain that cap-weighted indexes inevitably overweight overpriced stocks – is a “flawed” approach, in Goldman’s view. Plainer Talk Another popular way to describe smart beta to novices is to say it “blends” active and passive elements. Unfortunately, many of Goldman’s focus-group participants thought “active management” referred to frequent trading, and “passive management” meant “letting an advisor do the work for you.” Investors may be in desperate need of basic investment education, but in the meantime, advisors can address them with plainer talk – especially when discussing smart beta. Instead of defining it by what it’s not , or by talking about active versus passive management, Goldman recommends advisors explain the similarities between smart beta and traditional cap-weighted investing, while acknowledging the differences that can help smart beta outperform the broad market. Goldman’s Active Beta ETFs Goldman Sachs launched a pair of new active-beta ETFs itself last month. The first, the Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (NYSEARCA: GSLC ), debuted on September 17; while the second, the Goldman Sachs ActiveBeta Emerging Markets Equity ETF (NYSEARCA: GEM ), launched eight days later. The former quickly attracted more than $78 million assets under management (“AUM”), while the latter’s AUM tops $181 million. Both are based on ActiveBeta indexes that are designed to beat cap-weighted equivalents by weighing stocks according to four criteria: Value, Momentum, Quality, and Low volatility GSLC applies this methodology to U.S. large-cap equities. GEM does the same for stocks from emerging-market countries. Future Goldman ActiveBeta ETFs will apply the indexing strategy to European, international, Japanese, and U.S. small cap stocks. Smart Beta as Blank Slate The good news about widespread ignorance of smart beta is that advisors can approach clients with a blank slate. Goldman thinks advisors should explain that smart beta is like traditional index-fund investing, in that investments are selected by rules-based methodologies, but that smart-beta indexes are designed to outperform cap-weighted indexes by tilting towards favorable “factors” such as value or low volatility. Advisors shouldn’t try to get their clients to think about smart beta as something “radically different,” in Goldman’s view. Instead, smart beta should be considered a way to potentially outperform the broad market, while not paying a lot in fees. That’s the kind of “plain talk” everyday investors can appreciate. For more information, download a pdf copy of the white paper . Scalper1 News
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