FINRA Alerts Investors to Potential Risks of Smart Beta Products
Commentary by Steven Lofchie
FINRA warned investors of potential risks to consider prior to investing in a product linked to a "smart beta index."
FINRA defined a "smart beta index" as any index that is based on measures other than weighting by market capitalization. For example, they may be constructed using methodologies that rely on equal weighting of underlying component stocks, or measures such as volatility or earnings.
FINRA noted the potential advantages of utilizing smart beta products, such as diversification through exposure to nonmarket-cap-weighted indexes. Nonetheless, FINRA warned investors that smart beta products can also (i) carry investment risks; (ii) have different returns compared to investments that track market-cap-weighted indices; (iii) have higher expenses; and (iv) be complex or unfamiliar for individual investors.
Commentary
FINRA also noted the potential uncertainties and risks of investors' relying on hypothetical back-testing results. This should likewise be an area of focus for firms that use such results for advertising purposes.