The phrase “Smart Beta” represents investing strategies, which combines the advantages of passive investing strategies with upsides of active trading. These strategies attempt to passively track indices, while they also consider alternative asset weighting according to certain performance factors. The aim of these strategies is to achieve a better performance than the benchmark index.
Further, the term “beta” captures the relationship between a particular stock price movement and the movement of the whole stock market. If the beta of a stock is expressed as 1.0, it moves in tandem with the index. The value of 1.2 would represent that the stock is 20% more volatile than the market. In general, the higher the beta is, the stock is more volatile, and thanks to beta, an investor can create a portfolio that would match his risk tolerance.
Smart beta investing not only differs fundamentally from passive index-investing strategy but is also different from actively managed funds, where the manager of the fund picks particular stocks to beat the benchmark set by index. Smart beta strategies seek to obtain higher(alpha) returns, lower a risk exposure or achieve a better diversification of a portfolio at a lower cost, than active portfolio management would require. These positives can be achieved by implying well-known market effects like momentum, reversal, volatility or value.
The financial crisis in 2008 has wake the investor interest in smart beta funds, and the interest has been growing ever since. According to ETF.com, there was approximately $880 billion invested in smart beta funds. One of the most popular smart beta ETF is the Vanguard Value ETF. The stocks for the index are picked according to the forward price-to-earnings ratio (P/E), historical P/E, price-to-book ratio, dividend-to-price and price-to-sales ratio. Another popular smart beta fund is the Vanguard Dividend Appreciation ETF. This fund picks the stocks of firms, which have increased their dividends year over year.