Smart Beta ETFs

Smart beta ETFs (exchange-traded funds) screen and weight securities based on factors other than market capitalization. 

Most of the major indexes (e.g., S&P 500^® Index, Russell 1000^® Index, Russell 2000^® Index, MSCI EAFE Index) are market-cap weighted, meaning that the largest companies have the largest weight in the underlying index. Smart beta or strategic beta represents a different way of constructing the index basket. Popular strategic beta strategies include equal weighting, fundamental weighting, minimum variance, and low volatility. Smart beta strategies vary based on the universe from which securities are selected, economic (or other) factors screened, and weighting methodologies.

By under- or overweighting particular types of stocks, a smart beta strategy could coincide with your own view of the market. For example, you might want an equal-weight ETF if you believe a tilt toward smaller-cap companies makes sense. Alternatively, if you think the markets are about to get choppy and low-volatility stocks will be valued by other investors, you might want to invest in a low-volatility strategy. 

When looking at the past performance of smart beta ETFs (or the indexes they track), it's important to distinguish between actual and back-tested returns (the returns an index or ETF would have generated if it had been in existence). Since we have complete and accurate information about prior market conditions, it's possible that an index was constructed with a focus on the rearview mirror. In other words, the rules defining the index were chosen in order to provide what would have been strong performance in a prior period, but there’s no guarantee those conditions will continue or recur in the future.

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