So-called “Smart-Beta” Funds have become quite popular and are one of the fastest growing segments of actively managed funds, especially since the financial panic that began in 2007, and have taken in more than $500 billion, so we decided a closer look was warranted. Dr. Data (Michael Rechenthin, Ph.D.), the head of our research team, explains what Beta is, what some of these funds do with it, and how other firms completely misuse the term and more.
Dr. Data called the Smart-Beta funds low volatility funds and said there currently was more than $500 Billion residing in these funds. He explained that the focus of these funds is to try to minimize volatility instead of maximizing gains. Mike explained that many of these funds try to replicate an index with high correlation but low beta to the index and so these funds use active stock picking.
A table comparing the beta of KO (Coca Cola) and TSLA (Tesla Motors) was displayed. Mike explained that you can't look at beta without looking at correlation (since beta is the slope of the regression line). A segment of The Skinny on Options Data Science from July 29th, 2015, “What is Beta?” goes into more detail, but Beta tells us how much the stock has moved (on average) compared to a 1% move in an index, usually the S&P 500. A graph showed how smart beta funds would pick stocks with a high correlation and a low beta.
Mike noted one problem was that some of these funds have nothing to do with beta. Instead they are based on market cap and yield. Another problem he identified was even more troubling. By chasing certain stocks they are driving their prices up and their PE ratios are growing much higher than the overall index.
Finally, the entire concept of trying to minimize volatility, what these “Smart-Beta” Funds say they try to do was compared to the tastylive philosophy of taking advantage of volatility was compared. These funds pick stocks that historically have had low volatility to control volatility. The tastylive method sells over-priced implied volatility (IV) and this effectively reduces volatility. We learned in “Implied vs. Actual Volatility”, Skinny On Options Data Science from May 13th, 2015 that the more volatile the market is, the more options are generally overpriced.
Watch this segment of “The Skinny On Options Data Science” with Tom Sosnoff, Tony Battista and Mike Rechenthin (Dr. Data) for a better understanding of the “Smart-Beta” Funds and how their approach compares to the tastylive way.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.