‘Smart Beta’: Bridging Active Vs. Passive

November 26, 2014

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is by K. Sean Clark, chief investment officer of Philadelphia-based Clark Capital Management.

While “smart beta”—also called strategic beta—has become a buzzword, the concept is far from new.

Institutional investors have used alternative weighting and factor-driven strategies since the 1970s, though no one called them “smart beta” back then. Now that the term has become mainstream, nonmarket-cap-weighted ETFs have gained steam.

“Smart beta” approaches are currently the fastest-growing segment of the ETF marketplace, pulling in assets at twice the rate of the entire ETF market.

We’ve used a number of these sorts of ETFs, including the PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-47), one of the first of its kind that has been available to investors since May 2011. It now has almost $4.75 billion, making it very liquid and very tradable.

But before getting too much into specific vehicles, let’s define “smart beta” a bit more precisely and situate that in terms of how investors might use it.

What ‘Smart Beta’ Is

One complication of smart beta is that it lacks a standard industry definition. For the purposes of this article, we’ll use the following definition from Investopedia:

“The default setting for an ETF, a non-strategic beta ETF, is to be tied to an index whose components are weighted by market capitalization … A strategic (or “smart”) beta ETF, on the other hand, has its components weighted by some other criteria.”

At Clark Capital, it’s our belief that smart beta strategies offer exposure to the best of active as well as passive strategies, providing investors a valuable alternative that expands portfolio construction opportunities.

In my last ETF.com article, Moving Beyond Active Vs. Passive Debate, I discussed how the two styles of investment management complement each other, help build a more robust portfolio, and aid in risk management and diversification.

We believe that smart beta bridges the gap between active and passive. As Ben Johnson, director of Passive Funds Research at Morningstar, put it: “The common thread among [smart beta ETFs] is that they seek to either improve their return profile or alter their risk profile relative to more traditional market benchmarks.”

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