In the rapidly expanding exchange traded fund industry, alternative or smart-beta ETFs have experienced a rapid ascent as investors capitalize on actively managed styles in a passive index-based fund wrapper.

There are about 400 smart-beta U.S.-listed funds on the market, with $400 billion in assets under management, or about 20% of total U.S.-listed ETFs, report Anthony Effinger and Eric Balchunas for Bloomberg.

Arguably, it all started when the first non-traditional market-cap-weighted ETF hit the market and quickly evolved into customized indices that implement factors in selecting stock components.

For instance, the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), which tracks a Research Affiliates index, selects stocks based on book value, cash flow, sales and dividends. It is also one of the longest running smart beta ETFs on the market and will hit its 10th anniversary in December.

The strategic beta, scientific beta, factor-based investing or fundamental indexing ETFs are all based on a rules-based index that implement a highly regimented investment objective and mirrors actively managed styles.

Rob Arnott, chairman and co-founder of Research Affiliates, believes smart-beta helps sever the link between price of a stock and its weight in an index. Some argue that the alternative indexing style helps address some of the short-comings of market-cap index funds, which overweight outperforming stocks. [Arnott, Draper Talk Fundamental Indexing]

“By linking the weight to price, the more expensive something is, the bigger your holding,’’ Arnott said in the article, pointing out that cap-weighted fund investment means buying stocks because other people like them not because they’re better companies. “Why on earth would you want to do that?’’

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