Smart Beta 7: ETFs From The Inside Out

May 27, 2014

Dispensing with 'smart beta' leads to a clearer understanding of the ETF landscape.

This blog is the seventh and final installment of a series transforming our ideas about "smart beta." Part 1 started with the proposition that defining smart beta in an ETF context is essentially impossible. Part 2 laid out the ground rules to prove the point; Part 3 sunk noncap weighting as a method to categorize smart beta; and Part 4 took a wrecking ball to the notion that factor-focused tilts were synonymous with smart beta. Part 5 examined the dearth of real risk-adjusted outperformance in the realm of smart beta. Part 6 introduced a strategy rubric that looks through labels to describe what a fund actually does. This final blog caps the effort by tracking the economic principles behind each fund's index construction.

Before I killed off the term "smart beta" and introduced's strategy description, I was hounded for a count of "smart-beta funds."

That's how I opened this blog series, remember? "Everyone wants facts and figures about so-called smart-beta funds: How many are there? What's the biggest one? What's the total number of assets under management in smart-beta funds? How many launched in 2013?"

I refused to answer these questions, because I couldn't define "smart beta." Then I killed the term "smart beta." Out of its ashes, I proposed that we talk about a fund's strategy—what a fund does, and how it's constructed—rather than about its name or marketing.

Now, when a journalist at the Wall Street Journal calls, stubbornly asking, "What's the biggest 'smart beta' fund?" I can use our new strategy field to answer. recently identified 27 strategies in U.S.-listed ETFs. Strategy tags like "vanilla," "dividends" or "optimized commodity" explain how an index sculpts its opportunity set.

My best answer to the question, "How many 'smart-beta' funds are there in the U.S.?" is that I think investors are better off talking about investment strategies. Which ones seem smart to you, and for which purpose? But deciding which strategies are smart takes some effort.

More importantly, "smart" is very context-sensitive. What's smart for, say, my retired father-in-law might not be so smart for my 22-year-old niece.

My Second-Best Answer

Marketers and the press—the folks who want "smart-beta" statistics—aren't managing portfolios. They want to understand and ride trends, and they need tools for measuring investor behavior. And they ask us all the time—we've gotten a call every day about this last week.

For them, I've sorted the strategies into four groups: "vanilla," "active," "strategic" and "idiosyncratic."

Four Strategy Groups

I formed my groups by classifying the criteria that an index uses to select its investment universe, to choose securities within that universe, and then to weight the chosen securities. I focused on three key questions:


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