• Factor-based Indexes: Components are selected based on one or more fundamental factors and are weighted based on one or more fundamental factors. Factor-based Indexes can also be modified equal weighted, where stocks are first divided into tiers based on certain factors, and then equal weighted within the tiers.
• Low Volatility Indexes: Components are selected because they have exhibited lower volatility than the overall stock market and/or are weighted based on their historic volatility.
Managers who use these methods to create portfolios are, in effect, combining elements of active and passive investing by actively creating portfolios, which may then be passively or more actively managed on a day-to-day basis.
So, from our perspective, the difference between “beta” and “smart beta” may be the idea that smart beta seeks to provide an exposure with the potential to outperform the market, isolate or accentuate a certain characteristic of the market, or generate better risk-adjusted returns than the market, rather than merely measure the performance of all investable stocks in an equity market.
To learn more about smart beta, read our full paper here.
In future installments, we’ll discuss what to look for in smart beta investments—and much more.