The investment landscape is constantly evolving, and one of the most intriguing developments in recent years has been the rise of smart beta strategies. Among these, the Goldman Sachs Smart Beta portfolio available through Betterment stands out as a compelling option for investors seeking to enhance their returns while managing risk.
This portfolio strategy is designed for those willing to embrace additional risks in pursuit of potentially outperforming a traditional market capitalization strategy. It builds upon the core principles that have guided Betterment’s portfolio strategies, focusing on global diversification across stocks and bonds. However, it distinguishes itself by moving away from market capitalization weightings to seek higher returns.
The Essence of Smart Beta Investing
investment strategies are often categorized as either passive or active. Passive strategies, typically seen in index funds and ETFs, aim to track market returns based on asset class. Active strategies, on the other hand, involve fund managers actively buying and selling securities to beat benchmark indices. Smart beta funds, like those in the Goldman Sachs portfolio, occupy a middle ground, using a set of characteristics called factors to aim for outperformance while managing risk.
The term smart beta itself reflects this alternative approach. While conventional strategies assess beta, or market sensitivity, smart beta considers the By identifying a range of factors that may drive return potential, this strategy aims to outperform the market in the long term while managing reasonable risk.
The Five Core Principles of Betterment’s Investment Strategy
When developing new portfolio strategies, Betterment operates on five core principles: personalized planning a balance of cost and valuediversificationtax optimization and behavioral discipline. The Goldman Sachs Smart Beta portfolio aligns with these principles but configures cost, value, and diversification differently to pursue higher
This strategy incorporates additional systematic risk factors and seeks global diversification while overweighting specific exposures not included in Betterment’s Core portfolio. Despite its higher cost compared to the core strategy, it remains more affordable than the industry average. It is typically recommended for investors with a high risk tolerance and long-term savings plans.
The Driving Forces Behind the Goldman Sachs Smart Beta Portfolio
The performance and risk of a smart beta portfolio are driven by factors, which can be thought of as the variables that determine the underlying value of the risks taken. These factors reflect economically intuitive reasons and behavioral biases of investors, as studied in academic literature. The Goldman Sachs ActiveBetaTM equity funds, used in this portfolio, score stocks based on four key factors:
Good Value
This factor focuses on companies with solid earnings but relatively low prices, indicating they have been overlooked by other investors. Allocating to such stocks exposes investors to companies with high growth potential.
High Quality
High-quality companies demonstrate sustainable profitability over time. Investing based on this factor includes exposure to companies with strong fundamentals and potential for consistent returns.
Low Volatility
Stocks with low volatility tend to avoid extreme price swings and have historically shown higher returns than high volatility stocks. This factor capitalizes on the tendency of investors to overlook low-volatility stocks.
Strong Momentum
Stocks with strong momentum have recently trended upward in price. Investing in these stocks allows investors to take advantage of these trends, although it’s important to define momentum precisely to account for potential reversions to the mean.
The Goldman Sachs Smart Beta portfolio also targets a small operational cash allocation in taxable accounts, health savings accounts, and individual retirement accounts (IRAs).
The Potential for Future Outperformance
The factors driving the smart beta portfolio strategy have shown varying performance year-to-year relative to their market cap benchmarks. However, when combined, they have the potential to outperform these benchmarks. Historical data, such as the performance ranking of smart beta indices versus the S&P 500, illustrates this potential.
It’s important to note that while these factors have shown promise, they are based on historical analysis and cannot guarantee future performance. Investors should understand that the potential losses of this strategy can be greater than those of market benchmarks. For instance, during the dot-com collapse of 2000, the S&P 500 Momentum Index lost 21% while the S&P 500 dropped by 10%.
Despite these risks, the evidence suggests that smart beta factors may lead to higher expected return potential relative to market cap benchmarks. As such, the Goldman Sachs Smart Beta portfolio is offered to customers with long investing horizons who are seeking a more tactical strategy.
