Smart Beta 101: Understanding the Basics and Beyond

Smart beta is not a single strategy, but rather a broad term that encompasses various approaches to investing. These approaches use quantitative models to select stocks or bonds, rather than relying on traditional fundamental analysis.

Smart beta funds aim to capture specific market premiums, such as value or momentum, by using rules-based strategies. This can help investors diversify their portfolios and potentially improve returns.

The first smart beta funds were launched in the early 2000s, and since then, the space has grown rapidly. Today, there are hundreds of smart beta products available in the market.

Smart beta strategies can be categorized into several types, including equal-weighting, minimum volatility, and maximum diversification.

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Smart beta is a combination of both passive and active investing. It's an approach that brings together the efficiency of passive investing with the expertise of active managers.

A smart beta portfolio tracks an underlying index, making it a passive approach. This allows it to discover the most optimal investment opportunities.

The smart beta approach is also optimized using techniques that active portfolio managers utilize. This means it combines the best of both worlds to create a more efficient investment strategy.

A smart beta portfolio is efficient because it uses the same techniques as active managers to optimize its performance.

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Smart beta is all about finding ways to invest in the market in a more efficient way. The primary objective is to acquire one of three things: low-risk investments, alpha, or high diversification at a low cost.

Smart beta is applied to popular asset classes like commodities, equities, fixed income, and multi-asset classes. It's essentially a collection of strategies that highlight alternative index-building guidelines to capitalize on market inefficiencies.

The approach involves passively following indices, but with a twist. It takes into consideration factors like value, liquidity, quality, and momentum when building an index. This leads to a diverse portfolio with lower risks than traditional investing.

Smart beta strategies are defined and transparent, just like traditional index-following strategies. The primary difference is that smart beta focuses on areas within the market that are ripe for exploitation.

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Smart beta strategies aim to outperform traditionally weighted index funds by using factors like value or quality to construct indices that differ from traditional market capitalization-weighted indices.

Smart beta ETFs that track these indices are still passively managed, making it an approach to investing that is between active and passive in terms of strategy. This is why smart beta is considered an attractive option for investors looking for a balance between the two.

According to Eugene F. Fama and Kenneth R. French, a five-factor asset pricing model, smart beta strategies can provide outperformance relative to traditional active mutual funds. In fact, the assets invested in smart beta ETFs globally have reached a staggering $1.56 trillion at the end of February.

Smart beta strategies can also help reduce vulnerability to stock market volatility, making them a great option for investors who want to manage their risk. By using factors like value or quality, smart beta ETFs can provide a more stable investment option.

Here are some examples of popular smart beta ETFs that have shown impressive performance:

Smart beta strategies can outperform traditionally weighted index funds by reducing vulnerability to stock market volatility and providing outperformance relative to traditional active mutual funds.

One of the key benefits of smart beta is its ability to provide outperformance relative to traditional active mutual funds. According to Eugene F. and Kenneth R. French's five-factor asset pricing model, smart beta strategies can be used to construct indices that differ from traditional market capitalization-weighted indices.

Smart beta ETFs are still passively managed, making them an attractive option for investors who want to reduce costs while still achieving their investment goals. In fact, ETFGI reports that assets of US$1.56 trillion are invested in smart beta ETFs listed globally at the end of February.

Here are some key statistics on the largest smart beta exchange-traded funds (ETFs) traded in the United States as of October 11, 2024, by assets under management:

By investing in smart beta, you can potentially outperform traditional index funds and achieve your long-term investment goals.

Jack Bogle wasn't entirely sold on strategic-beta funds, calling them "stupid" because investors often pick the hot factor, which they're almost assuredly wrong about.

Bogle's concern was that investors would chase performance, just like sector fund shareholders who buy high and sell low.

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Smart beta investment strategies aim to combine the benefits of passive investing and the advantages of active investing strategies. By using alternative index construction rules, smart beta seeks to outperform traditional market capitalization-based indices.

Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. This approach involves using alternative weighting schemes such as volatility, liquidity, quality, value, size, and momentum.

One of the main complaints about market-cap-weighted indices is that they prioritize yesterday's stock winners. Smart beta strategies aim to address this issue by giving weights to investments based on fundamental characteristics instead of market capitalization.

There are multiple smart beta strategies for portfolio managers to choose from. Some may opt to follow or construct an index that gives weights to investments based on fundamental characteristics, while others may pursue a risk-weighted approach.

The risk-weighted approach involves the creation of an index that is based entirely on how volatile the market is projected to be in the future. For example, a manager may analyze an investment's track record of performance and use the information to determine how it correlates to possible future performance and risk.

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Smart beta strategies may use various factors such as quality, minimum volatility, size, momentum, and value to drive returns. These factors have historically proven to be drivers of return and can be accessed through factor ETFs.

As of February 2024, smart beta ETFs managed roughly $1.56 trillion in combined assets. This growth is a testament to the increasing popularity of smart beta strategies among investors.

Here are five key factors that have historically driven portfolio returns:

Smart beta has come a long way, with over 1,041 smart beta ETFs trading in the U.S. as of October 2024.

The smart beta approach was initially theorized through Modern Portfolio Theory (MPT) by American economist Harry Markowitz, who aimed to develop a portfolio that is diversified in an optimal way.

Smart beta funds have gained immense popularity, commanding some $1.56 trillion in total cumulative assets as of October 2024, up from $616 billion in 2016.

The history of smart beta is a fascinating topic. It all began with Modern Portfolio Theory (MPT) by American economist Harry Markowitz, who theorized the best ways to develop a diversified portfolio.

The smart beta approach was initially focused on answering the question of diversification, enabling a portfolio to grow along both active and passive lines. This marked a significant shift in the way investors thought about portfolio management.

The term smart beta was allegedly invented by the consulting firm Willis Towers Watson in 2006. Although the original source is unclear, the term has stuck.

Sixty years ago, Nobel laureate William Sharpe theorized that stock returns came from two causes, which he called beta and alpha. Beta measures the level of a portfolio's exposure to the overall stock market.

Over time, practitioners turned Sharpe's mathematical definition of beta into slang, applying it loosely to indicate the performance of an asset class.

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Smart beta funds have seen a significant surge in popularity among investors. As of October 2024, there were approximately 1,041 smart beta ETFs trading in the U.S.

These funds are attracting a lot of attention, despite charging higher fees than their vanilla counterparts. Investors are willing to pay more for the potential benefits of smart beta investing.

The popularity of smart beta funds is evident in their growing assets under management. As of October 2024, smart-beta funds commanded some $1.56 trillion in total cumulative assets, up from $616 billion in 2016.

Smart beta can help you diversify your portfolio through its variety of alternative index exposure.

Smart beta strategies can be based on various factors such as volatility, momentum, earnings, or dividends, and these factors can also exist across different asset classes.

BlackRock offers several fixed income smart beta ETFs, which provide a range of options for investors looking to diversify their portfolios.

Smart beta funds are typically not actively managed, but their alternatively weighted construct allows for more frequent fund analysis and rebalancing than traditional index funds.

Diversification is a key concept in investing, and smart beta can help you achieve it. Smart beta's variety of alternative index exposure can help you diversify your portfolio. By using smart beta, you can spread your investments across different asset classes and sectors, reducing your reliance on any one particular stock or market.

Smart beta strategies may be based on equity factors such as volatility, momentum, earnings or dividends, but factors also exist across asset classes.

Smart beta funds are typically not actively managed, which means they don't have a fund manager constantly making decisions about where to invest the money.

Their alternatively weighted construct, however, may provide for more frequent fund analysis and rebalancing than traditional index funds, giving them the potential to outperform a market index.

BlackRock offers several fixed income smart beta ETFs, showing that smart beta strategies can be applied across different types of investments.

Smart beta is a relatively new investment approach that's gaining popularity. It's a way to invest in the stock market by following a specific set of rules or strategies.

Investors can use smart beta to gain exposure to specific factors such as value, momentum, or quality, which can help reduce risk and increase potential returns. This can be achieved through the use of ETFs or mutual funds that track these factors.

Smart beta can be more cost-effective than traditional active management, with fees often lower than those of actively managed funds.

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Smart beta strategies are an efficient way to access the market, using systematic and rules-based approaches, such as an index.

They can be accessed through ETFs, which are cost-effective vehicles for these strategies.

Smart beta strategies can be used to complement or replace active funds and broad market index funds.

This can help enhance a portfolio's returns and diversification, or reduce risk.

ETFs are popular vehicles for smart beta strategies, and are often used to implement them.

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iShares offers a range of resources to help you pursue your financial goals.

You can view iShares factor ETFs to see how they might complement your portfolio.

Factor investing 101 is a great place to start, as it explains the role of value, quality, momentum, size, and minimum volatility in your investment strategy.

Index funds are a simple, low-cost way to gain exposure to markets, and they revolutionized investing by making it more accessible to everyone.

Discovering the potential of factor investing can be as easy as understanding how factor ETFs work and how they can be used to complement your portfolio.

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