Smart Beta & Fundamental Index
Smart beta strategies offer the potential for better-than-market returns, without sacrificing the benefits of traditional passive indices, by using fundamentals rather than price to select stocks, thus breaking the link between price and weight.
First introduced in approximately 2008, the term smart beta is now one of the most popular concepts in modern finance. Yet confusion remains about what smart beta actually means. While arguably complex in theory, it is simple in practice.
At its core, smart beta breaks the link between price and weight by systematically selecting, weighting, and rebalancing portfolio holdings based on factors or characteristics other than market capitalization. By doing so, it offers the potential for better-than-market returns without sacrificing the benefits of traditional index-linked strategies, specifically, broad market exposure, rules-based implementation, transparency, and low cost.
Investors have been able to invest in alternatively weighted indices for longer than the term smart beta has been around. For example, the Fundamental Index™ strategy, which weights securities by four measures of company size—sales, cash flow, dividends + buybacks, and book value—rather than market capitalization was launched in 2005, three years before anyone had heard of the term smart beta!
Smart beta has become so popular that the term is now controversial. Semantics aside, the concept is a significant development in investment management that helped to bridge the gap between active and passive investing.
Research Affiliates, our sister company, has published a number of articles to help investors
weed out the noise in smart beta and maximize the benefits of the strategy.