What is smart beta strategy?
Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization-based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way.
Smart beta refers to an enhanced indexing strategy that seeks to exploit certain performance factors in an attempt to outperform a benchmark index.
Smart beta can work fairly well because most stock market indexes are built around capitalization weight. This means that they prioritize stocks in the index based on its total market capitalization. That is generally a reliable indicator of how the market is doing overall.
Smart Beta is a blend of active and passive investing. Smart Beta investing follows an index but also considers alternative factors in choosing the stocks from the index. Smart beta ETFs commonly include strategies that are equally weighted, fundamentally weighted, factor-based, or low volatility.
This means that smart-beta funds may be able to identify stocks that are undervalued or have strong growth potential, which could result in higher returns for investors. Numerous studies have shown that smart-beta strategies have outperformed traditional index funds over the long term.
Unfortunately, according to the author smart beta portfolios do not consistently outperform and when they do produce appealing results, they flunk the risk test.
Smart Beta strategies provide exposure to specific factors or weighting methodologies that may offer diversification benefits and reduce concentration risk. Additionally, the rules-based approach to portfolio construction and rebalancing can help manage risk.
- Smart beta funds may have lower liquidity and higher volatility than traditional index funds. ...
- Moreover, it may happen that a smart beta fund does not outperform the market in certain situations or timelines.
Risk: Smart beta ETFs may be riskier than standard beta ETFs, depending on the factors used to construct the portfolio. For example, a momentum-based smart beta ETF may be more volatile than a market index during a market downturn.
Dave divides his mutual fund investments equally between four types of funds: Growth and income, growth, aggressive growth, and international.
Why is it called smart beta?
The term smart beta grew out of attempts by people in the industry to explain the Fundamental Index approach vis-à-vis existing passive and active management strategies.
Smart beta ETFs, also known as "strategic beta" or "factor-based" ETFs, use rules-based indexes. They are a low-cost way to access smart beta strategies.
- Equal weightings. ...
- Fundamental weightings. ...
- Factor-based weightings. ...
- Low volatility weightings.
Industry standard smart beta strategies offer exposure to long- term factors such as value, growth, quality and low volatility, or some passive combination of these. Active quantitative strategies typically include much more sophisticated factors/signals, and these may be short, medium or long-term in nature.
1) The global market for strategic-beta ETPs has matured
As of Dec. 31, 2022, 1,384 strategic-beta ETPs held roughly $1.53 trillion of assets worldwide. For most of the decade-plus, strategic-beta ETPs made inroads against their peers that are benchmarked to more-traditional indexes.
To achieve their goals, smart beta funds track indexes that are constructed around one or more factors. For example, a fund that is based on the quality factor would track an index that is composed of companies that generate superior profits, strong balance sheets, and stable cash flows.
Value will return from the dead and the global leading companies will falter eventually, just like they always do, according to the godfather of smart beta, Rob Arnott, founder and chairman of Research Affiliates.
Smart alpha requires greater effort, which results in higher management costs relative to smart beta strategies. The manager assessment process for smart alpha may also be more demanding. Smart beta strategies, because of their simplicity, bear a resemblance to passive investments.
Smart beta strategies are active in that they deviate from market capitalization weighted indices by design. But many are implemented in a passive fashion, following relatively static rules for portfolio inclusion, weighting, and rebalancing.
Advantages & Disadvantages of Measuring 'Beta'
Beta can be calculated for different periods, so two reported betas on the same security may not be the same. Regardless, it's important to understand that beta is not a perfect predictor of future relative market volatility, and is effectively an approximation at best.
How do I create a smart beta portfolio?
We create smart beta portfolios by selecting the 30% of all stocks with market caps in excess of $1 billion and ranked most favorably by a factor. Stocks are weighted by market cap and excess returns are calculated by shorting the stock market index. We then change the weighting to equal weighting.
Value investors are always looking to buy undervalued stocks at a discount in order to make profits with minimal risk. There are a variety of tools and approaches that investors can use to try to determine the true value of a stock and whether or not it's a good fit for their investment portfolio.
Key Takeaways. Beta is a concept that measures the expected move in a stock relative to movements in the overall market. A beta greater than 1.0 suggests that the stock is more volatile than the broader market, and a beta less than 1.0 indicates a stock with lower volatility.
Issues with the Beta Estimate
In actual practice, there are no indices that come close to the market portfolio. Instead, the equity market indices and fixed income market indices include only a subset of the securities in each market and are not comprehensive.
A beta greater than 1 indicates a stock's price swings more wildly (i.e., more volatile) than the overall market. A beta of less than 1 indicates that a stock's price is less volatile than the overall market. A beta of 1 indicates the stock moves identically to the overall market.
