A few years ago, investing in mutual funds and exchange traded funds was simple. You had actively managed or passive index-based investments. Now, investors will have to discern the subtle differences in strategic- or smart-beta indices, a middle group that falls somewhere between active and passive strategies.
“There’s a difference between indexes that weight securities according to market capitalization, such as Vanguard’s offerings or any company’s S&P 500 funds, and indexes that incorporate viewpoints,” writes John Rekenthaler, Morningstar‘s Vice President of Research.
For instance, Research Affiliates’ Fundamental Indexes are among a growing crop of smart-beta index providers that allocate toward specific investment attributes, such as low-volatility that favors less risky assets, as opposed to traditional market-cap-weighted indices that tilt toward the largest company stocks.
Rekenthaler even argues that some of these smart-beta fund providers make claims that sound suspiciously active, which adds to his point that along with traditional active and passive fund strategies, we should also make way for strategic- or smart-beta index as a third distinct class.
“A passive fund is a fund that does not express a viewpoint,” Rekenthaler said. “An index fund is a fund that mimics a list of securities. Those are two different things. Thus, a strategic-beta fund is an index fund, but it is not a passive fund.”
Smart-beta ETFs are considered a mix of both passive index-based offerings and actively managed styles. Specifically, the enhanced, factor-based, smart-beta ETFs will passively track an underlying index. However, the underlying index implements actively managed strategies, such as focusing on low-volatility, momentum and value, among others.
“Strategic-beta funds are the modern equivalent of the quantitative fund,” Rekenthaler said. “Popular in the 1970s and 1980s, quantitative funds mined databases in the attempt to pick stocks. Strategic-beta funds similarly mine databases, but to select factors – or betas, as they call them.”
Consequently, when talking about strategic- or smart-beta ETFs, Rekenthaler suggests that the strategies may be better suited to be compared to active management as the ETFs cost more than other index funds and try to outperform their traditional beta peers.
For more information on market indices, visit our indexing category.
Max Chen contributed to this article.