For starters, underlying securities are adjusted by relative price and profitability. The underlying index may overweight stocks with lower relative prices and underweight names with higher relative prices. The index can also adjust for profitability by overweighting stocks with higher profitability and underweighting those with lower profitability.
The index strategy also implements market-capitalization adjustments where it increases the weights of smaller companies within the eligible universe and reduces the weights of larger names. The weighting methodology suggests that the ETFs may follow a more equal-weight tilt with a greater tilt toward smaller companies than traditional market-cap weighted index funds.
According to academic research, these small capitalization, lower relative price and higher profitability factors used in crafting the underlying smart-beta indices have been linked to higher expected returns.
Financial advisors who are interested in learning more about factor-based, smart-beta sector investments can register for the Tuesday, September 20 webcast here.