Smart Beta
AdvancedSmart beta is an investment approach that tracks an index built using rules other than market capitalization, such as factors like value or low volatility, or equal weighting, typically through low-cost exchange-traded funds.
Traditional index funds weight each company by its market value, so the largest companies dominate. Smart beta funds use alternative rules to choose and weight holdings, aiming to improve returns, reduce risk or both.
Common smart beta approaches include equal weighting, where each company has the same weight; fundamental weighting, based on measures such as sales or dividends; and factor-based indices targeting value, momentum, quality, size or low volatility.
For example, an equal-weighted index of 500 large companies gives each company a 0.2% weight, increasing exposure to smaller companies compared with a standard market-weighted index.
Smart beta sits between passive and active investing. It follows transparent rules like an index fund, but deviates from the market like an active strategy. Fees are usually higher than for standard index funds but lower than for active funds. Like factor investing, smart beta strategies can underperform the broad market for long periods, and the name is a marketing term rather than a guarantee of smarter results.
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