Instead, people may be better served through defining smart beta by what it is not. Specifically, smart beta does not follow a traditional market-weight index – an index that weights components based on the size of the company, so larger companies have larger weights. Instead, smart beta may weight components based on a given investment goal, such as low-volatility, so the stocks that exhibit the least volatility have the largest weight in the underlying index.
The rise of smart-beta indices comes as more see a flawed approach in a market capitalization-weighted index, which provides the largest weight to the biggest companies, since investors will be exposed to overpriced stocks. However, Goldman pointed out that the majority of investors still have a favorable opinion of traditional cap-weighted ETFs and lack familiarity with financial terms that describe smart beta strategies.
“We believe approaches which seek to critique traditional market-weight index ETFs make it more difficult to understand these strategies for what they can offer a portfolio,” according to Goldman.
Consequently, investors who want to better understand smart beta should understand the similarities and slight differences with traditional market-weight indexing. Additionally, investors should be aware the risks and potential rewards of smart beta strategies in their effort to outperform traditional indices.
For more information on rules-based investment strategies, visit our smart beta category.
Max Chen contributed to this article.