iQ All Cap Smart Beta Model
INTRODUCTION
Beta is a measure of a stock’s relative price volatility compared to the general stock market. A stock with a beta of 1.0 has the same price volatility as the S&P 500 index. High-beta stocks have betas above 1.0 and move by a larger percentage than the S&P 500 moves, both during S&P up moves and down moves. The rationale given for recommending the purchase of high-beta stocks is that higher returns must be linked to higher volatility (Beta).
However (based on a 40-year Harvard study of stock returns between 1968 and 2008), we've learned that low-volatility and low-beta portfolios offered an enviable combination of high average returns and small drawdowns. This outcome runs counter to the fundamental principle that risk is compensated with higher expected return. Investing in low-beta stocks may be the “the best of both worlds” because you get both a higher return and lower volatility.
The All-Cap Smart Beta Model represents an equal-weighted portfolio of Small, Mid, and Large cap stocks with low 5-year beta and volatility.
PROCESS
The iQ All Cap Smart Beta Model employs the following unemotional, rules-based process:
Start with the largest 1500 domestically-traded companies.
Sort by 5-year beta and keep the lowest 10% (150 companies).
Sort by 12-month share buyback and operating earnings yield and keep the top 30 companies.
Choose the top 10 companies by sorting by 5-Year Seasonal Relative Strength divided by 5-Year Standard Deviation.
This model reconstitutes every February, May, August, and November.
The potential benefits of low-beta stocks
Investing in low beta stocks involves choosing stocks that tend to be less volatile than the broader market. Beta is a measure of the volatility of a stock in relation to the overall market. A stock with a beta of less than 1 is considered to be less volatile than the market, while a stock with a beta greater than 1 is considered to be more volatile.
Investing in low beta stocks may have several potential benefits, including:
1. Lower risk: Low beta stocks are less volatile than the market, which means they may be less risky for investors. These stocks may be a good option for investors who are looking to reduce the risk in their portfolios.
2. Consistent returns: Low beta stocks tend to have more consistent returns over time compared to high beta stocks. This can be especially important for investors who are looking for stable, long-term returns.
3. Diversification: Investing in low beta stocks can help to diversify a portfolio. By adding stocks that are less correlated with the broader market, investors may be able to reduce the overall risk of their portfolio.
4. Potential for higher returns: While low beta stocks may be less volatile than the market, they may still have the potential to provide solid returns. Over the long term, low beta stocks have historically outperformed high beta stocks.
It's important to note that investing in low beta stocks may also have some potential drawbacks, such as the potential for lower returns during market upswings. Additionally, low beta stocks may not be suitable for investors who are looking for high-growth opportunities or who have a high-risk tolerance.
Smart beta strategies are designed to track customized indices, utilizing various factors to enhance potential returns or manage risk. These strategies may not necessarily replicate traditional market-weighted benchmarks. It's crucial to understand that smart beta performance can differ significantly from standard index funds and may not always outperform the broader market. Investors should carefully assess their financial goals, risk tolerance, and investment time horizon before considering smart beta strategies.