The smart-beta ETFs follow a rules-based selection process that is seen as a multi-factor approach, combining a number of factors in a single portfolio. Securities are adjusted by relative price and profitability. The underlying indices may overweight stocks with lower relative prices and underweight names with higher relative prices. The indices can also adjust for profitability by overweighting stocks with higher profitability and underweighting those with lower profitability.
Related: Money Managers Tap Academic Research to Craft Enhanced ETF Strategies
The underlying indices also implement market-capitalization adjustments where they increase the weights of smaller companies within the eligible universe and decrease the weights of larger names. The weighting methodology help the ETFs follow a more equal-weight tilt with greater exposure to smaller companies than traditional market-cap weighted index funds in an attempt to capture the size premium and limit risks associated with high-flying, large-cap stocks that may be overbought in an ongoing bull market rally.
The new class of smart beta ETFs offer investors the ability to revamp core portfolio positions with strategies that potentially enhance returns and diminish drawdowns to generate improved risk-adjusted returns. Investors may completely replace traditional positions with these smart beta products or simply augment current positions with a smart beta tilt.
Financial advisors who are interested in learning more about portfolio construction can register for the Thursday, November 2 webcast here.