Smart Beta Vs. Factor Funds: What's The Difference?

May 10, 2018

Smart Beta Vs Factors:

What Is Smart Beta?

  • Smart beta ranks companies by their size rather than by their market capitalization
  • When creating an index, the company’s size is used as an anchor to determine its weighting; that weighting is rebalanced if prices move extravagantly
  • If a company’s price is soaring but the fundamentals of the company have changed, the index will trim the position; if the prices fall and the fundamentals haven’t changed, the index buys the stock.
  • Takes into account alternative ways to measure worth, e.g., volume, liquidity, momentum
  • Sometimes called equal weight, fundamental weight, alternative beta
  • No single approach
  • Usually long only

What Are Factors?

  • An asset pricing model created by University of Chicago professors Eugene Fama and Kenneth French (now at Dartmouth)  
  • Fama and French found 5 main factors are associated with higher returns: value stocks, size momentum, low volatility and quality (also known as dividend payers); A 6th factor, yield, is sometimes included in the main factor definition count
  • Different factors work during different times in the market cycle, but they can’t be timed
  • Usually a long/short strategy
  • Usually market-cap weighted, but can be used with fundamental weighting
  • Nontraditional factors such as share buybacks, and environmental, social and governance tilts are becoming more popular as factor investing grows in use

 

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