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Can smart beta work in DC plans?

Sep 11, 2017
By BlackRock

View the latest insights from industry experts.

How does smart beta work in DC?

Smart beta’s potential for enhanced returns and improved risk management is gaining interest from defined contribution plan sponsors. But DC plans have concerns around transparency, cost, participant communications and fiduciary responsibility. Can smart beta play a role in DC?

For insight, we turned to Sara Shores, Head of our Factor Based Strategies Group, and Nick Nefouse, Head of U.S. DC Investment Strategy, to explore the possibilities. View highlights from their conversation below.

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    Nick Nefouse: So what we're focused on now is: How can we utilize smart beta strategies within defined contribution to help investors achieve their outcomes? When we go back to the basics, Sara, what is smart beta, and why is smart beta important today?

    Sara Shores: Smart beta is the long-only and index-driven form of factor-based investing. So we follow preset rules to try to tilt portfolios towards rewarded factors, screening for companies that have low prices, relative to fundamentals, or high-quality balance sheets, for example. And, in doing so, we build a strategy that seeks increased returns or less risk, relative to a standard cap-weighted strategy.

    Nick Nefouse: And are there certain flagship strategies you'd want the audience to know about?

    Sara Shores: Two flagship strategies that we spend most of our time on in smart beta: One is Minimum Volatility, and the other is a Diversified Multi-Factor strategy.

    So a Minimum Volatility strategy seeks to provide market-like returns with less risk. A Multi-Factor strategy is looking to provide diversified exposure across many factors to give a robust source of incremental returns. Now, all of the ideas that we've just talked about are not particularly new. You've been hearing about things like quality or value from fundamental managers for many, many decades. So the ideas themselves have been proven to work over time. What is new is the way that we can target them in a more systematic and efficient way.

Bringing the best thinking of lifecycle and smart beta strategies to target date funds

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    Sara Shores: You and I have both been taking taxi cabs for, probably, most of our adult lives. Uber did not invent the taxi cab, but they have transformed the way that we interact with transportation and the efficiency with which it's delivered. And I think of smart beta as very much the same way. It's taking a time-tested idea and making it more efficient, more accessible, to investors at a lower cost.

    Nick Nefouse: Yeah, that's exactly why we launched LifePath Smart Beta in November of last year, which I know you and I really drove a lot of this process forward with other people at BlackRock.

    But it was all about this idea of being able to access these factors that we otherwise wouldn't have been able to in a low-cost, transparent way.

    Sara Shores: What I loved about the partnership between our teams developing LifePath Smart Beta was, I think, it really brought the best thinking of our Retirement Team and our Smart Beta Team together. So, in the context of LifePath Smart Beta, we take the flagship glidepath from our target date fund series and look for ways to improve potential returns, using rewarded factors and layer in another source of diversification.

    So in a traditional target date fund, we have this equity/bond glidepath, where we shift from riskier assets when you're young and want to seek returns to more safe assets as you near retirement. Well, we do that with the smart beta investments, as well. So, in the younger dated portfolios, we use more return-seeking strategies – like a Diversified Multi-Factor strategy – to try to add incremental returns.

    As you shift along the life path towards retirement, we emphasize more defensive strategies like Minimum Volatility. So the mix of smart beta strategies shifts along the lifecycle just as the equity/bond mix shifts along the lifecycle. And that really introduces a new source of both returns and diversification.

An evolution in line with broader trends in
defined contribution

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    Nick Nefouse: When you think about the broader trends within defined contribution – of low cost, transparency – these still hold true with factor-based strategies with smart beta. They're rules-based. They're transparent. So we like the low cost that we get out of the factor-based strategies. They're going to be lower cost than traditional active. They're very transparent and really easy to understand, because these are rules-based.

    So if you go back to smart beta in general: We've seen a lot of companies come into the market with smart beta. What makes BlackRock unique in managing smart beta?

    Sara Shores: I think it's really our experience and our expertise. BlackRock has been managing factor-based strategies, perhaps by another name, for well over 30 years. It was our predecessors in our Active Equity Team that launched the first known computer program to screen equity markets for companies with high dividends and attractive valuations back in 1979. So we have been doing this for a very long time.

    That becomes important because the differences that you see across managers are quite pronounced, even for ideas that seem to be well understood. Value is value. How much difference could there possibly be across smart beta value strategies? A lot. Because the choices that you make in how you measure the factor, how you implement the factor, how you control for risk – lead to very, very different outcomes. So that experience in both defining and implementing these strategies really leads to some important best practices that can create better results for clients.