Smart Beta

Understanding Smart Beta
What is Smart Beta?

Smart Beta is a broad term used to describe systematic rules-based investment strategies that do not use conventional market capitalization weights to construct a diverse portfolio. In an attempt to deliver a better risk and return trade-off than conventional market cap-weighted indices, these portfolios use alternative weighting strategies based on measures such as value, volatility or dividends.

Smart Beta products do not usually involve as many active investment decisions as pure active management, but they are slightly more complex than market-weighted passive products. This is reflected in the typical cost for these strategies, which tends to be in the middle between active and passive strategies.

How are IBKR Asset Management Smart Beta portfolios different from other portfolios on IBKR Asset Management?

The IBKR Asset Management Investment Management team, under the leadership of Chief Investment Officer Sanjoy Ghosh, manages IBKR Asset Management’s Smart Beta portfolios. The team is responsible for undertaking a systematic process to select stocks, construct the portfolios, continually monitor for any relevant events and periodically (at least quarterly) rebalance the portfolios.

Together with several other portfolios lines (e.g. Asset Allocation, Index Tracker portfolios), the Smart Beta portfolios are IBKR Asset Management’s in-house portfolios. Other portfolios on the IBKR Asset Management platform are managed by third-party investment advisers or hedge fund managers. These portfolio managers fund and trade a proprietary manager-owned brokerage account. In contrast, for each IBKR Asset Management Smart Beta portfolio (or any other in-house portfolio), IBKR Asset Management funds and trades a proprietary IBKR Asset Management-owned brokerage account. In both cases, each trade made by the portfolio manager (or IBKR Asset Management) is automatically replicated in clients’ brokerage accounts based on which portfolios the clients have selected to invest in.

Why should I invest in a Smart Beta portfolio?

Smart Beta portfolios are similar in some respects to passive index funds, except that the rules used to construct these portfolios are designed to slightly outperform a conventional passive index fund, particularly when adjusting for risk. Smart Beta portfolios typically charge higher management fees than passive index funds. But these portfolios have lower management fees than pure active investment strategies.

These features make these portfolios suitable for a client that desires exposure to the broad stock market but is not sure which portfolio to pick.

Working with fractional shares
What is a 'fractional share'?
A fractional share is a unit of stock that amounts to less than one full share. More information here
Why are fractional shares useful?
Fractional shares allow you to invest in diverse portfolios with many holdings even with a low investment amount. In essence, fractional shares allow investors to invest lower amounts in a larger selection of stocks, some of which may be too expensive for the investor to purchase in whole shares. IBKR Asset Management is able to diversify the Smart Beta Portfolios (and the other in-house portfolios) and offer them to IBKR Asset Management clients investing a relatively small amount due to its ability to trade fractional shares.
Can fractional shares be traded on public exchanges?
Stocks cannot be traded in fractions on public exchanges, which means that you need a counterparty willing to transact with you in fractional shares.
How can I trade fractional shares in my IBKR Asset Management account?
Interactive Brokers LLC, IBKR Asset Management’s affiliated broker-dealer, facilitates trading in the Smart Beta Portfolios (and the other in-house portfolios) by executing all fractional share orders on behalf of IBKR Asset Management clients against one or more liquidity providers. These liquidity providers will sell or buy fractional shares that IBKR Asset Management clients would not otherwise be able to trade in the open market.
Is there anything else I should know about the fractional share trades in my IBKR Asset Management account?
Note that there is a potential conflict of interest in connection with fractional share transactions in your IBKR Asset Management account as Interactive Brokers LLC will act as broker for both IBKR Asset Management clients and the liquidity provider counterparty to these transactions. You have consented to these transactions in the Investment Management Agreement. You may revoke your consent to such transactions at any time by written notice to IBKR Asset Management or Interactive Brokers, but you will no longer be able to invest in the Smart Beta Portfolios as they rely on fractional shares.
How do corporate actions work for fractional shares?
You will receive payments or value commensurate to your fractional ownership in the case of stock dividends, stock splits, mergers or other mandatory corporate actions (including cash dividends). You will not, however, have any voting rights or a mechanism to make voluntary elections on your fractional share holdings, and will not receive any shareholder documentation for holdings of less than one share.
How do I liquidate my holdings in a Smart Beta Portfolio when I own fractional shares?
You can redeem from a Smart Beta Portfolio and close out your Smart Beta positions at any time. If you do this, Interactive Brokers LLC will sell your whole shares to the market and your fractional shares to the liquidity provider. You will incur commissions in connection with these trades.
What will happen to the fractional shares if I want to transfer my Smart Beta investment to another broker?
You will not be able to transfer fractional share holdings to another brokerage firm and will need to sell them to the liquidity provider. You will incur commissions on these trades.
How lockout periods work
What is the ‘lockout period’ and how does it apply to my IBKR Asset Management account?
A lockout period starts 3 business days before each Smart Beta portfolio (or any other in-house portfolio) rebalance and ends right after each rebalance. During each lockout period, we will not allow clients to make any initial, additional or recurring investments in any Smart Beta portfolios. If you request such a transaction during a lockout period, IBKR Asset Management will send your transaction request for execution on the first trading day following a rebalance.
Does this mean I cannot redeem my money from Smart Beta in the lockout period?
No. The lockout period does not affect any partial or full redemption instructions for Smart Beta portfolio investments you place in your IBKR Asset Management account (i.e. partial or full divestments from any of the Smart Beta Portfolios). You may redeem some or all of your investments in any Smart Beta Portfolio at any time. But, if you have a cash (rather than margin) brokerage account at Interactive Brokers LLC and engage in redemptions less than 3 business days after a rebalance, Interactive Brokers LLC may require you to fully pay for any purchases in your account on the date of each trade for the next 90 days.
Why do you have a lockout period?
Pursuant to Regulation T (see related SEC Investor Bulletin), cash accounts can make purchases with unsettled sale proceeds as long as they do not run afoul of the freeriding restriction by selling unsettled securities (i.e. do not close positions within 3 days of opening them). Since investments made within 3 days of a rebalance might lead to a position being closed at the time of the rebalance, we restrict such investments to prevent violations of the freeriding restriction.
How will I know whether one of my investment instructions has occurred during a lockout period?
The confirmation you receive when you submit an investment instruction will indicate that the portfolio is under lockout and will also inform you of the date on which your instruction will be processed.
How will I know when the investment instructions I place during a lockout period will be processed or when the lockout period ends?
The confirmation you receive when you submit an investment instruction will indicate that the instruction is pending and will also inform you of the date on which your instruction will be processed. You can cancel this instruction anytime before the specified processing date.
Outside of a lockout period, when will my instructions to invest in any Smart Beta portfolio or redeem any of my Smart Beta portfolio investments be processed?
To avoid price swings around market open and close, client requests to invest in or redeem any investments in the Smart Beta Portfolios will be processed in the order in which they are received between 9:35 am and 3:50 pm ET.