Smart beta funds look to tweak index fund investing to the next level by strategically weighting stocks inside the funds based on objective factors. And, typically robo-advisors choose the investments within the fund and manage its smart beta investment strategy based on a set of factors or criteria.

Finding a system that beats the stock market is akin to the search for the Holy Grail. It’s a glorious and righteous quest that has gone on for centuries and will continue to do so, long after we’re all gone. That’s where smart beta funds and indices come in to play in the stock market.

Smart Beta Funds, Smart Beta Indices and Smart Beta Investment Strategies?

What Is the ‘Beta’ in Smart Beta?

In stock market lingo, an investment’s beta measures its amount of volatility when compared to the market as a whole, typically the S&P 500 index. All types of investment ranging from individual stocks, bonds, mutual funds, and the like have a beta.

Betas typically fall within the range of zero to two. The S&P 500 index is the barometer for the overall stock market and has a beta of one. Investments and individual stocks are ranked by how much their prices move or deviate from the standard beta of one.

A fund with a beta of one typically advances or declines in value in lockstep with the overall stock market.

A stock or mutual fund with a beta of two is expected to behave like this:

When the market goes up 10% and the fund with a beta of two (and a correlation of 0.95) might increase 21%. If the S&P dropped 10%, this fund might decline 19%.

You don’t have to express beta in whole numbers either. A stock can have a beta of 1.3, for example, and that means it theoretically has 30% more volatile than the overall stock market. Equally, if a mutual fund or exchange traded fund (ETF) has a beta is 0.75, it is theoretically 25% less volatile than the overall stock market.

A fund or financial asset with a negative beta should decline in value when the market rises and vice versa. Adding a smart beta fund could be a good addition to diversify an investment portfolio.

By checking out a fund’s beta you can gain insight into how your investments might perform, in comparison with the returns of the overall market.

What are Smart Beta Indices?

Typically, market capitalization,or market cap, rules the day in passive index fund investing. Market capitalization is calculated by multiplying a company’s share price by number of shares outstanding. The resulting dollar value is a way of measuring the size of a company.

Traditional indexes weight the stock holdings within the index based upon their market cap. So Apple (AAPL), with a market cap of 815.39 B would have a greater weight in an S&P 500 index fund than Alaska Air Group (ALK), with a market cap of 10.61 B.

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