Leave Your Cap On
The simplicity of noncap-weighted is its downfall as a smart-beta definition. Indexers have been skillful, adaptive and inventive in creating investable products that access quirky parts of the market, using a rich set of selection and weighting schemes.
These adaptations are smart, and surprisingly common in the ETF landscape. Not every alternatively weighted fund fits our presumptions of what smart beta is.
As I mentioned when I introduced the smart-beta definition ground rules, the groupings that result from definitions of smart beta have to make sense to the people who will use it. Alternatively weighted funds fail this test.
Factor exposure does no better, and for the same reasons. So, my wrecking ball will slam into factor exposure in my next blog, and I hope you join in the fun.
Endnotes: using ETF.com’s Finder to replicate my results
Pure cap weighting:
Weight = market cap or value
Weight = single asset, niche excludes optimized
Plain vanilla: all of the above, plus:
Active per SEC = no (applies in all cases)
Case 1) Selection = market cap or value, Weight = market cap or value
Case 2) Weight = market cap or value, underlying index = S&P, Selection = proprietary (this step includes the S&P US 1500 and Global 1200 series, which are subject to profitability screens and committee selection but are nonetheless quite representative of the opportunity set).
Case 3) Weight = single asset, niche excludes optimized
Case 4) Selection = futures liquidity, Weight = production (this selects for the GSCI, which is the most market-caplike commodities index).
Case 5) Weight = market cap or value, Selection = AMT Free, credit downgrade, credit rating, developed market currencies, financials, industrials, maturity, revenue backed, time since listing, US$ denominated, utilities. (Sometimes fixed-income funds are so specific that they need four ECS fields to describe their market segment.)
At the time this article was written, the author held no positions in the securities mentioned. Contact Elisabeth Kashner, CFA, at [email protected].