Our research team is having many conversations on how one should view smart beta indexing strategies and what factors are driving the results. We attempted to quantify the various factors at play. My colleague explained our general approach to this analysis in a prior blog post, but in general we evaluated indexes according to their exposure to various factors, from their “market” risk, “size” exposure, “value” tilts and “momentum” tilts.

In this post, I want to focus on the size exposures inherent to our Index approach, as one of the most common misconceptions regarding smart beta indexes is that they “incorporate a small-cap tilt” to their construction. Some do, but WisdomTree’s traditional Indexes do not.

For definitions of indexes in the chart, please visit our glossary.

Equal Weighting: We can start with the classic, intuitive example of equal-weighting the S&P 500 Index to illustrate how different weighting methodologies can influence the size factor of a particular index. We see that the S&P 500 Index registers a negative value (meaning that it’s tilting toward exposure to larger companies) whereas the S&P 500 Equal Weight Index registers a positive value (meaning that its size exposure is tilting toward smaller companies).

o It’s interesting that the S&P 500 Equal Weight Index has a very similar size factor to the WisdomTree MidCap Dividend Index (WTMDI).

Size Factor Takeaways: The WisdomTree LargeCap Dividend Index (WTLDI) and Equity Income Index (WTHYE) indicated size factors more than twice that of the S&P 500 Index. When critics characterize smart beta as being a tilt to small caps, they are clearly not talking about WisdomTree’s large-cap dividend or earnings approaches, which are more large cap than the S&P 500. Part of this distinction is caused by the fact that WisdomTree selects stocks by market capitalization for its size-based segments, and then weights securities by dividends or Earnings Streams®. In our opinion, that selection rule results in purer size segmentations across the spectrum.

• Interestingly, the WisdomTree Dividend Index, which includes all dividend payers and has more than twice the number of securities of the S&P 500, still has a great large-cap bias and more loading to large caps than the S&P 500 (more negative size factor than the S&P 500 Index).

Most Small-Cap Tilted: The WisdomTree SmallCap Earnings Index had the largest factor sensitivity to small caps of all the indexes included in the analysis.

What can be done with this factor information to impact strategic investment considerations?

Take 1: Targeting Allocations to Match the Size Exposure of the S&P 500 Index

One of the most widely followed equity indexes is the S&P 500. We mentioned that our Indexes have more of a large-cap bias than the S&P 500. A natural question is, what combination of indexes with our large-cap bias would produce a size exposure similar to the S&P 500?

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