However, as the popularity of the ETF investment vehicle grows, more sophisticated investors who are looking beyond traditional beta-index funds have gone to ETF providers, asking for intelligent strategies, similar to actively managed styles, condensed into a cheap ETF wrapper.

Consequently, a new breed of smart beta ETFs were born, combining traditional styles that one would find from active managers with a passive index based structure. Through the marriage of active and passive, we are come out with smart beta ETFs that passively track customized or rules-based indices that specifically target specific factors, such as low volatility, value, dividends, momentum, size, and quality, among others, to potentially enhance returns and diminish portfolio volatility.

Many market observers have quickly categorized this new set of smart beta ETFs as anything that follows customized indices other than established or traditional market capitalization-weighted index funds.

Proponents of smart beta indexing argue that the new indexing methodologies help cover the inefficiencies or risks associated with traditional market cap-weighted methodologies. Specifically, some argue that due to the market cap-weighted indexing methodology, the largest and typically most overbought companies make up the biggest weights, leaving investors at risk to sell-offs in these high flying stocks.

Alternatively, smart beta indexing, some would argue, can potentially help guide investors toward undervalued or underappreciated segments of the market to better drive returns or manage risk exposure.

For more on Smart Beta ETFs, visit the Smart Beta Channel home page.