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Special Report: Where Smart Beta Works Best for High Net Worth Clients

By Garrett Keyes October 30, 2018

Smart beta investing calls for a more individualized approach for high net worth clients. Part 2 of a 5-part Special Report on Smart Beta.

Incorporating smart beta investments into client portfolios may sound easy to some advisors. The strategies are sold as ways to drive returns and lower risk by combining properties of active and passive strategies. But FAs in the know argue it may be more complicated than many of their peers realize because different client segments require different smart beta approaches. In particular, using smart beta with high net worth and ultra-high net worth clients requires a different approach than for mass affluent clients, Chris Cordaro, CIO of $2.7 billion AUM RegentAtlantic says.

Smart beta strategies can be applied in a wide variety of ways depending on an advisor’s goal, including screening index funds to lower risk profiles or selectively adding investments to existing index holdings, advisors say. For RegentAtlantic, using smart beta for HNW and UHNW clients means developing instruments internally rather than buying solutions off the rack, Cordaro says. Portfolios are constructed by picking individual stocks with a smart beta approach rather than investing in smart beta funds, he says.

Advisors must effectively educate clients on what smart beta is before incorporating it.
Chris Cordaro
RegentAtlantic

Many high net worth clients come to RegentAtlantic already possessing a portfolio of stocks, so rather than sell their existing portfolios, RegentAtlantic aims to incorporate their existing holdings into its own smart beta strategy, says Cordaro. This can be done by analyzing a client’s investment portfolio and picking individual stocks to give them exposures to certain parts of the market they may be lacking, he seems to say. And by doing so, HNW and UHNW clients can have more tax-efficient portfolios and RegentAtlantic can implement strategies that obtain their target factor weightings, he insists. While Cordaro’s process of emulating smart beta is labor-intensive and requires a high degree of skill, he believes it’s the best way to customize smart beta for this most discerning of client segments.

Customized or off the rack, some FAs say smart beta should only be used by HNW and UHNW clients, who have unique needs in terms of tax efficiency, specific investment goals and lowering overall costs in otherwise expensive investment management needs.

High net worth investors, with sophisticated portfolios, are best placed to use smart beta to its maximum effect, most advisors agree. The strategies’ best quality in such circumstances is often their ability to zero in on particular investment needs. According to commentators, some of the most useful strategies for HNW and UHNW taxable portfolios are low volatility, value, quality, or momentum stocks. Using smart beta to target identified needs in a HNW portfolio allows advisors to concentrate their active management efforts – and fees – on more difficult or labor-intensive investment goals.

Peter Mallouk

Therefore, clients with less than $400K in investible assets should not use smart beta investments and just stick to indexes, Peter Mallouk, president of $36.5 billion RIA Creative Planning, insists. As a broad group of strategies, Mallouk is unconvinced smart beta works all of the time. But he does see the strategy being specifically effective for high net worth clients in the U.S. small cap value equity space. If high net worth clients have small cap stocks and want to increase returns without using smart beta, he says they would otherwise have to pile up the risk. Smart beta ETFs are Mallouk’s vehicle of choice because they function as almost a “hybrid index” and don’t have a lot of turnover in investments when compared to mutual funds, he says. Smart beta mutual funds tend to have higher investment turnover, which can create more taxes, says Mallouk.

No matter their feelings about certain vehicles, FAs must effectively educate clients on what smart beta is before incorporating it into their client portfolios, Cordaro says. And that can be a challenge.

Even by UHNWs, smart beta is not easily understood, and the biggest key to explaining the strategies to clients is not calling them smart beta, says Cordaro. He argues the term uses off-putting investment terminology and by asking clients to understand it, you are asking clients to understand what beta means. While some clients may understand the concept of beta, many will really have no idea, he says. Every advisor knows that the more confusing it becomes to understand an investment, the worse it is for clients' comfort, he says.

For FAs pitching smart beta investments to UHNW clients, Cordaro offers some simple guidance: “Tell them you are going to buy low and sell high in a systematic, disciplined fashion.”

This business is confusing enough. Advisors don’t need to make it more confusing by adding unnecessary terminology, he concludes.

Next: How to use smart beta for mass affluent clients.