Gareth Stobie: Going beyond the ETF-obvious with “smart beta”

As passive investing takes an overdue hold in South Africa, Exchange Traded Funds are becoming increasingly popular among private investors. To meet this demand, ETFs are evolving from pure index trackers into portfolios that offer exposure to particular themes and sophisticated concepts like smart beta. Newly re-launched Coreshares, part of Grindrod Bank, sees this as a massive opportunity – and sees education as its key driver in a country where ETFs are in their infancy. In this Special Podcast, Gareth Stobie guides us onto the next level – and shares his pick of the ETF pack.  – Alec Hogg  

This special podcast is brought to you by Coreshares.  Coreshares’ Gareth Stobie is with us in the studio to talk about Smart Beta or Factor-based Index Investing.  I guess most people know what an Exchange Traded Fund is and what an Index Fund is as well, but now you’re taking it to a new level.  What’s Smart Beta?

I suppose there’s a lot of lingo in there, isn’t there?  To begin with, let’s understand Beta.  Beta is the financial guys’ definition for the broad market.  It’s ‘let’s meet after work today, have a beer, and talk about the markets generally’, we’d generally be talking about the All Share Index or the Top 40 Index, which is a Vanilla Beta Index.  An index created, using size (so the largest company has the largest shares and the smallest company has the smallest share) – that’s a traditional Beta Index (the market).  Smart Beta is a variation of Beta where it looks at the market and says ‘what factors/strategies over extended periods of time, have proven to outperform Beta’ in two ways.  Either they’ve shown to outperform Beta by giving excess returns or they’ve been able to outperform Beta in terms of reducing risk, but still giving you a good return.  You could look at it from either way.

If you talk to Money Managers, then they will say ‘we’ll give you Alpha’.  How does Alpha come into this Beta, without getting too many Greek letters?

Alpha is whatever outperformance you can achieve over Beta.  If the market gave you what it was at 11/12 percent during 2014 and a Fund Manager gave you 15 percent, then he generated three percent of Alpha.

How did he do that?

He did it by trading contrary to what the general index did.  For example, if the general index has Naspers at ten percent, he might have gone at 12 percent.  If the general market had Anglo at four or whatever it is, he might have gone five or he might have gone three, and through underweighting and overweighting the general market, he was potentially able to outperform the market.  Of course, many do actually underperform the market, so Alpha’s the term for outperforming the market and it’s what Active Managers always try to do.  It’s what they sell themselves on, basically.

It’s what they should do; otherwise, they shouldn’t be in business.


We have Beta, which is the market.  Then we have Alphas, which is those Fund Managers who take positions and bets, and trade from one stock to another.  Then you have Smart Beta, which sounds like a combination of the two.

Correct.  Smart Beta looks at factors in the market that, over periods of time, have tended to give outperformance – have tended to give Alpha, relative to a general Beta.

Like what?

Well, there are a few different ones.  Many of the index houses have summarised them into six big themes.  If I could name those, they are Low Volatility, Momentum, Value, (which perhaps I’ll talk about just now) Quality, Dividends, and Size.  They are some of the major building block themes for Smart Beta.

If you like high dividend earning stocks, would they necessarily outperform over a long period?

Certain dividend-paying strategies do tend to outperform over periods of time.  Take Value, for example.  You can have a Smart Beta strategy that tries to package Value.  Now, there are tons of Active Managers around the market.  You’d say they’re a Value Manager.  What Smart Beta says is ‘Mr Active Manager, when you say you’re a Value Manager, what do you actually mean’ and they say ‘well, we look for stocks that are trading at discounts to their historical averages or we look at stocks that have low PE’s or high dividend yields, etcetera’.  They have different definitions for what Value Investing is, so the index houses have said ‘well, that’s interesting.  Why don’t we simply build rules on the index, which basically, do what you’re trying to do within your investment committees?’  They’ll say ‘we want stocks in this index that have a high dividend yield or a low PE’.

Does it introduce some sort of filter?

Absolutely.  It’s all rules-based, so you have all the other benefits of passive.  It’s rules-based.  It’s highly transparent and low cost because once the index houses generated this it’s just system-generated.  You don’t have to pay a whole lot of expensive analysts to pore over information.  The systems generate the information and it’s highly effective.  You can work with these factors, depending on how you see the market.  With Momentum strategy for instance, if the markets are running then you want to be in the Momentum strategy because that’s going to capture those stocks that are running the most.  On the contrary, if you’re worried about the levels the markets are trading at, you can go for a risk-off type of strategy, which is a low volatility type of strategy.

It seems to put a lot more responsibility onto the investor.

It does and it comes with a word of caution in that you can invest in Smart Beta strategies and underperform the general markets, in the same way that you can invest with an Active Manager and underperform the general market.

It depends on the view at that point in time and whether it works out.

Correct.  Where the market’s moving to in the index world is that most index houses like ourselves, would encourage users to package one or two Smart Beta strategies together in an equity strategy so that you are complementing your approach.  Certainly, sophisticated investors like Multi Managers etcetera, would have highly sophisticated means in which to choose these different factor-based indices.

Gareth, so you’d have a core (and we actually spoke to your colleague Chris Rule, about satellite investing), which would probably be your Index Fund or your Index Tracker.

Your Beta – in this example.

Around that, you might think ‘I’m worried about the current state of the stock market.  I’m worried about the Rand’.  Could you then bring in Smart Beta themes that would take account of those views and either protect you or perhaps, give you some outperformance?

Exactly right.  You’d use it as either a risk mitigation tool (like a low volatility strategy) or you could use it as a sort of aggressive tool and go into a Momentum-type strategy.

How many of those Smart Beta products do you have?

We currently have two.  Later in the year, we’ll have three.  The two that we currently have is Low Volatility – looking at stocks in our market, which have demonstrated low levels of volatility.

Which means what?

Low levels of standard deviation.  I don’t want to get too technical again.

They’re therefore shares that are more conservative.  They’re not going to bounce up and down.

Correct.  We have a Smart Beta called Dividend Aristocrats, which is an S&P Index again that looks at stocks, which have generated consistent dividend payments over time and have grown those dividend payments over time.

It’s always easy to back-test but before you launch something, you would have looked at the history and I guess, hope that it continues into the future.


How have those two done (when you back-tested them)?

Well, we have live data now for a year.  We listed our two Smart Beta ETF’s in April last year and I’m proud to say they’ve done exceptionally well, particularly the Dividend Aristocrats ETF’s with over 30 percent returns over that year.  On the back-tested basis, it has outperformed the normal Beta returns over a ten-year basis, as well.  Again, whether that’s absolutely sustainable in all markets…probably not, so it does need to be offset with other types of strategies.  As a part of your portfolio, it’s a great building block, particularly for clients looking for income as well as looking for inflation hedge on that income.

What’s the smart call?  How much would you have in Beta (Index Tracking) and Smart Beta, in a portfolio of 100?

It depends on how sophisticated you are.  You could potentially have no Vanilla Beta at the core and just combine various Smart Beta indices at the core.

And the cost…

Smart Beta is slightly more expensive than Vanilla Beta because of the additional intellectual property that goes into creating those indexes and then maintaining indexes, but not significantly so.  It’s still, significantly cheaper than an Active Manager who says that they’re a Value Manager but really, is generating portfolios that look the same as a Value Index might.  It’s expensive, relative to Beta but way cheaper than Active Management.

It all comes down to actually, understanding what you’re buying.  Beta is the Index Tracker for a completely unsophisticated investor.  That’s the way to go.  As you study more, learn more, and get more of a view/opinion, you might then add Smart Beta, which costs you a little bit more but certainly, not as much as giving your portfolio to an Active Manager who would clearly, for their expertise, demand higher fees.

That’s right.

How’s your portfolio structured now?

My personal portfolio: I love Dividend Aristocrats.  I think it’s a solid investment thesis.

Even now…even though it’s had such a fantastic run in the last year.

Yes.  I think that companies that have paid dividends and have managed to grow those dividend streams over time…it’s a wonderful (what the index houses call) quality filter.  You tend to end up with a quality portfolio of Blue Chip companies that have maintained dividends and grown dividends over time.  The strategy works in the South African context and its tended to work in all the other markets as well.  If I look at the markets, just generally at the moment, we’ve had a wonderful run over the last few years.  Many would be tempted to take money off the table or to de-risk themselves somewhat.  In that context, low volatility works rather well in that environment, as well.  If I were buying a Smart Beta for my kids, it would be Dividend Aristocrats.

Gareth Stobie is with Coreshares and this special podcast was brought to you by Coreshares.


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