Investment Ideas

Smart Beta

What is Smart Beta?

Smart beta – along with strategic beta, factor investing, and a few other related terms - generally  refers to a category of rules-based approaches to investing. These strategies seek to capture specific factors, or investment characteristics, that active managers commonly seek exposure to, while preserving the benefits of traditional indexed investments, including transparency, consistency and low cost.

In an environment of potentially extended low growth and increased uncertainty smart beta gives you the opportunity to potentially achieve higher returns than the traditional market-capitalisation benchmark over time and/or lower risk and cost using efficient implementation strategies.



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The Benefits of Smart Beta

Smart beta offers active investment outcomes within a relatively low cost, index-like structure. Serving as a complement to both active and traditional index strategies, smart beta may offer investors:

  1. Improved risk-adjusted performance potential.
  2. Preserved popular features of traditional indexed strategies.
  3. Reduced manager risk.


Smart Beta Factor Facts

There are broadly accepted five main factors — also known as premia or exposures — that have historically outperformed the market capitalisation benchmark over the long term: Value, Size, Low Volatility, Quality, and Momentum:

  • Value: Over the long term, low valuation (relatively low priced) stocks have outperformed high valuation (relatively high priced) stocks.2
  • Size: Small-capitalisation stocks have been shown to outperform their large-capitalisation peers over time and across many markets.3
  • Low Volatility: Creating a portfolio with lower volatility or tilting towards lower risk stocks can likely generate a higher risk-adjusted return than traditional financial theory would suggest. The evidence shows that the risk/return relationship holds between asset classes, but not within the equities asset class.
  • Quality: Over time, higher quality companies have been shown to outperform lower quality companies. Quality focuses on debt levels, stability of earnings and profitability.
  • Momentum: Market efficiency proponents believe that stock prices have no memory but empirical evidence shows something else: stocks that have done well recently tend to carry on doing well in the near term, and stocks that have performed poorly continue to underperform.4

While different firms recognise slightly different factor lists, the factors above appear in most published lists.

In addition to this list, some firms recognise ‘Yield’ as another factor. This states that over the long-term, stocks with higher dividends tend to perform better than stocks with lower yields. This is typically linked to the Value and Quality factors.5

Diversify with Multi-Factor

The above factors perform differently in different market conditions. Quality and low volatility strategies tend to outperform in market downturns, while value strategies usually deliver strongest returns in risk-seeking environments.

Several factors can also be combined in a single portfolio. For example, an equity portfolio can have consistent exposure to both growth and defensive factors, aimed at providing smoother returns as market conditions change. This potentially results in diversification between factors, a more consistent return stream over the long run and a portfolio that’s overall more responsive to market cycles.


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Needle in a Haystack: Selecting a Smart Beta Strategy in an Overcrowded Landscape

Interest in smart beta is growing – at the end of December 2018, there were 1,493 smart beta equity ETFs and ETPs globally. Within such a crowded landscape, investors need to conduct ample due diligence before selecting a strategy. This worksheet provides a thorough framework to consider when choosing the most suitable smart beta ETFs.     

As of 31 March 2019. All figures in USD.

2 “The cross-section of expected stock returns,” Fama, E. & French, K., Journal of Finance, as of 6/1992, 47, 427 –465. Fama, E., & French, K., “Common risk factors in the returns on stocks and bonds,” Journal of Financial Economics, Volume 33, issue 1, as of 6/1992, 3 –56

3 “The cross-section of expected stock returns,” Fama, E. & French, K., Journal of Finance, June 1992, 47, 427 –465; Fama, E., & French, K., “Common risk factors in the returns on stocks and bonds,” Journal of Financial Economics, Volume 33, issue 1, as of 6/1992, 3 –56

“Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” Jegadeesh, Narasimhan and Titman, Sheridan, The Journal of Finance, Vol. 48, No. 1, as of 3/1993, pp. 65 –91

5“Stock Returns and Dividend Yields: Some More Evidence,” Blume, M.E., The Reviewof Economics and Statistics, 1980, 62 (4) 567 –577

6Morningstar Direct, Morningstar Research, as at 31 December 2018.

Important Information 

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing.