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