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

Companies that typically have $10 billion or more in market capitalization are considered large cap stocks. Mid cap companies are between $2 billion and $10 billion in market capitalization. And, small cap companies are typically between $300 million and $2 billion.

Smart beta funds are based on smart beta indices that use an alternative method to group companies. Instead of grouping stocks within the smart beta index according to market cap, they might weight them based on other factors such as:

  • Dividends
  • Growth rate
  • Sales
  • Cash flow
  • Book value
  • Low volatility
  • and a host of other metrics

With smart beta funds, computer algorithms or robo-advisors weigh stocks by objective rules or factors to screen which stocks to purchase in an effort to outpace a straight index over extended periods of time.

Smart beta mutual funds and exchange-traded funds review academic studies to see which rules or factors have correlated to stock market prices. The smart beta funds goal is to beat the market-cap weighted indexes.

Towers Watson, the professional services firm, created the term, ‘smart beta funds,” but investors have used beta as a trading strategy since the 1970s. The first smart beta ETF was created in 2003. Smart beta funds eliminate the size bias in investing in favor of an objective rules-based methodology to find stocks poised to beat the stock market.

What Is a Smart Beta Investment Strategy and Can it Beat the Market?

A smart beta investment strategy seeks to beat the traditional stock market indices by purposefully weighting, rebalancing and choosing the stocks of companies based on objective factors. The smart beta approach seeks to improve on the passive lazy investment strategy.

Investors look to smart beta investments to outperform the market.

As of September 2015, investors have over 450 smart beta investment choices between mutual funds, index funds, and ETFs run by robo-advisors and traditional financial advisory firms alike. These smart beta funds manage over $510 billion in assets.

Check out Personal Capital’s Sector Weight Smart Beta Approach

These advisors use factors such as low volatility, momentum, quality, growth, size, dividend growth, sales, cash flow, book value, share buyback, contrarian, and other characteristics to determine their fund’s underlying holdings. While smart beta strategies seek to outperform benchmark indexes for investors’ portfolios, fund managers can’t assure investors of gains that beat the market.

An Investco study found that smart beta funds can beat the returns of market weight indexes. The investment firm examined data over a 24 year period from 1991 to 2015 and the results were that specific smart beta ETFs outperformed the S&P 500 index. The study looked at five smart beta investment strategy factors: quality, value, small tilt, momentum and low volatility.

Not all smart beta strategies are alike. There are a lot of different methodologies available. Each one has advantages and drawbacks. Like all investments, it’s important for investors to carefully examine the smart beta mutual fund, ETF, or index fund they are investing in. You must understand which single or multiple factors each investment fund uses.

Should I Try a Smart Beta Investment Strategy?

Some robo-advisors and traditional advisory firms use computer algorithms to create smart beta funds. These smart beta funds and approaches don’t weight stocks or funds by market cap but by objective factors or a distinct set of rules by which to screen stocks for purchase. They create these smart beta funds to try and outpace an index (primarily the stock market as a whole) over extended periods of time.

Bonus; Advanced Investor Resources

If you’re looking for an approach to beat the market, you might investigate a smart beta strategy. Smart beta funds can diversify your portfolio and potentially counteract some stock market volatility.

When the smart beta strategy strives for an inverse relationship between the smart beta funds and the market, you might gain an advantage when the market declines. And this bull market will turn around eventually. Ultimately, you should always weigh your their investment objectives and understand your time horizon when putting money into the markets.

This article was republished with permission from Barbara Friedberg Personal Finance.