Beta is a measure of risk. If a stock has a beta of one, it goes up and down by the same percentage, day-to-day, as the market does. Investment portfolios have a beta component, which corresponds to their general exposure to a broad market average, like the S&P 500. By definition, if you own an index of the entire market, your beta is one.
Smart beta is a rules-based approach that reduces costs by limiting investment discretion. It is attractive because it is inexpensive and has the potential to add value when compared to traditional active management. It’s is a way to have broad market exposure and diversification but not hold the same weightings as the general index. Fundamental indexing, that holds companies in proportion to their earnings, or revenues, or dividends, is one such approach. So are sector allocation limits.
The key is the cost to the investor. If these managers charge just as much as the average mutual fund—1 ½ percent—then the lower costs of these strategies lining the manager’s pocket. But if the fees are lower, then investors benefit.
Smart beta can be a reasonable way to limit expenses and grow returns. But don’t be dumb about reading the fine print!
Douglas R. Tengdin, CFA
Chief Investment Officer