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.

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.

On Demand Webcast: Looking Under the Hood of Smart Beta ETFs

Dimensional Fund Advisors has been implementing factor-based strategies for over thirty years and have transitioned what they do on a daily basis into an ETF model through smart beta or factor indexing. Deroian pointed out that many associate smart beta with Fama and French’s three factor model, but many may not know that Fama and French are associated with Dimensional Funds. Dimensional would take the academically backed research and incorporate it into an investment model that could help investors better access the markets.

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