What is Smart Beta? What are Smart Beta ETFs?

An ETF is a passive instrument, tracking an underlying Index cost efficient and 1:1. The performance of an ETF is just as good as the Index it represents. An outperformance (Alpha) is per definition not possible as the ETF just delivers cheap beta (market exposure).

Smart Beta hence is an alternative approach of a classic, passive ETF mixed with an active stock selection. The ETF itself is still passive but the Index it represents is not static but smart.

While the most common Indices (i.e. MSCI World) weight their components by market-size (free-float), Smart Beta Indices are structured to weight the same components in an alternative (smart) manner in order to allow an outperformance (alpha) vis a vis the index.

Types of Smart Beta ETFs

The following Smart Beta ETF Strategies are common::

  • Momentum - Stocks are being weighted by their momentum, which should lead to an outperformance
  • Value - Stocks are being weighted by Value criteria in order to reach a sustainable performance.
  • Low / Minimum Volatility - Stocks with the lowest volatility have the highest weight. This should lead to a less volatile performance.
  • Quality - Stocks are being weighted by quality criteria.
  • Equal Weight - All Index Components get the same weight in order to get a broader diversification.
  • Minimum Variance - Stocks are being weighted in a risk adjusted manner in order to get the optimal diversification with the lowest possible risk.

The development of Smart Beta Strategies is not finish yet and over time we will see which strategy is worth an investment. The industry is trying new approaches but time will tell which alternative index strategies will survive.

In a simple performance comparison on USD Basis for Smart Beta Indices based on the MSCI USA (2013-06-01 to 2015-12-15) the gap of 22% is quiet large, while the classic MSCI USA is in the middle and Quality Growth and Momentum are leading.

 

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