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DOL Fiduciary Rule
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New DOL Regulation and Smart Beta

Investors need advisors to cut through the crowded space to understand what they're getting.

By Timothy M. Baker

One of the most impactful issues to hit the investment industry in quite some time is the recent DOL ruling. While at its broadest, the ruling requires advisors to be fiduciaries to their clients for qualified retirement plans, this will have further-reaching consequences. For example, it is probably unlikely advisors would treat one client differently depending on whether the account was retirement or not, so this is likely to blanket all clients, not just retirement ones.

Furthermore, this will have implications for products recommended to clients as there could be a trend toward advisory, rather than brokerage or commission-based, accounts and therefore lower-cost (including tax) options. That brings us to one of the most impactful trends in the investment industry, which is actually well underway. That is the trend away from active mutual funds and toward ETFs. Initially this trend was to passive, market-cap weighted index ETFs, but we have seen a proliferation of new ETFs in smart beta, or factor, index ETFs.

Why is this important? Because investors are beginning to realize that a lot of return from actively managed mutual funds in the past has essentially been delivery of factors like value, quality, duration, etc. and they can now access those factors more cheaply in low-cost ETFs that tend to be highly tax efficient. As noted above, investors are voting with their feet. And active managers are taking notice.

A Rapidly Growing Space

In recent years, not only have smart beta ETF launches increased dramatically, they have also grown to almost half of all ETF launches (from about a quarter). Many of these are emanating from traditional active managers that recognize the trend toward ETFs, but acknowledge that it is difficult to compete in traditional market cap as that space already has a handful of strong players with dominant market share.

So why should anyone care? As investors think more carefully about using smart beta to access factors as a way of improving returns and/or reducing risk in a cost- and tax-efficient manner through ETFs, it is important to understand what one is actually getting. This space is crowding and will do so much more in the coming months and years. As it does, every manager must differentiate what they do. That is the crux of why investors should care because this will become confusing. One manager might say you only need two factors. Another might say four. Some might say you need value, momentum and quality, while others might incorporate volatility, or yield, or size. To compound matters further, managers do and will continue to define factors differently. Is value simply price-to-book? Or should it include price-to-sales? Price-to-earnings? Is profitability sufficient to define quality? Or should there be some element of income stability? Should one measure volatility simply as historical stock variance? Or should correlations be considered? 

To summarize, the primary sources of differentiation among strategies may include:

  1. How many factors to combine and in what weights?
  2. What factors should actually be included and excluded?
  3. What company or stock metrics should actually be used to define those factors?

That last one actually has meaningful implications for factor behavior and can make one value portfolio perform very differently than another seemingly similar value portfolio.

Finally, away from factors, what are acceptable ETFs to use? As mentioned, we have seen an increase in launches, but we also see a number of closings every year, which leaves investors looking for a suitable replacement.

What is an investor to do? As the industry becomes increasingly complex and the DOL ruling pushes investor assets toward more cost-effective solutions, it is more and more important to have a partner. Investors should consult with financial professionals who in turn work with third-party providers tasked with evaluating the landscape.


Timothy M. Baker, CFA, is Director of Product Strategy at Symmetry Partners, LLC, a Registered Investment Advisor located in Glastonbury, Conn. The firm designs and manages portfolios built on academic research.

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