Schwab Cooks Up Smart Beta Hybrid

“The beauty of cap-weighted is the fact that it’s low cost and will track the market,” Sturiale says. “But one downside of cap-weighted is that the size of the company and number of shares outstanding are going to dominated by the biggest companies in that index — companies like Apple and Exxon Mobil — but we still believe in them and that’s why we have a weighting to them.

“Fundamentally weighted indexing is more expensive,” Sturiale continues, “but also allows us to use other factors like price-to-sales or dividends to weight the portfolio so that the size of the companies and number of shares outstanding don’t necessarily dominate the performance of that index.

“In different time periods, cap weighted will outperform and at other time periods, the fundamentally weighted will outperform; they’re both good strategies, both are cost effective, so why not combine them in a portfolio that over long periods should outperform either one and smooth out the volatility of either one?” he says.

In other words, the cap-weighted component keeps costs down and keeps in the investments tracked to benchmarks while the lower allocation to smart beta boosts returns and the MarketTrack package provides a low-cost vehicle (the four funds are all in the 60-basis point range) to hold the investments.

A recent Schwab white paper offers more of the investment theory behind the combo product, including analysis suggesting that smart beta and cap-weighted indexes perform better at different times, thus enhancing the funds’ risk characteristics.

Crucially, the MarketTrack Portfolios are also periodically rebalanced to stay aligned with their objectives.

The hybrid product is CSIM’s big product initiative for 2015, with Sturiale anticipating no new products on the immediate horizon.

“The thing about Schwab is we’re always listening to our customers to see what might be of value to them…We’re pretty diligent about when we roll things out; we want to make sure we’re rolling products out that our clients want to use,” he says.

The investment management exec sees three areas of current growth — in cap-weighted ETFs; fundamental strategies (Schwab offers six standalone fundamental ETFs and six standalone fundamental mutual funds, in addition to the four MarketTrack funds); and in target-date funds.

“What we like to do here at Schwab is provide choice for our clients…advisors can pick those ingredients [i.e., the standalone products] and put them together in ways appropriate for their clients,” says Sturiale, who oversees CSIM’s $260 billion in assets under management.

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