With today’s heightened search for differentiated sources of return, it’s no surprise that “Smart Beta” has stepped onto the scene. Sometimes known as advanced beta, alternative beta, or enhanced beta, it’s an umbrella term for rules-based investment strategies that don’t use conventional market-cap weightings.
The shortfalls of passive replication
Users of smart-beta funds criticize market-cap weighting because these indices give the most influence to the largest companies and overvalued ones. That’s a potential problem because these companies may underperform the broad market over the long period.
Smart beta also takes risk exposures, such as value vs growth, which may or may not pan out.
The economics of smart-beta funds
Such funds cost less than actively managed funds, since there’s less daily decision making for their managers. Smart-beta funds, however, have higher trading costs than passively managed funds. So in comparison smart-beta funds are the pricier option. Just a few of the factors you need to weigh when deciding if smart beta is the intelligent choice for you.
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