In recent years smart beta strategies have seen increasing investor demand, thanks to their combined offering of benefits from passive and active investing. Smart beta strategies aim to give investors the opportunity to potentially achieve higher returns than the traditional market-capitalisation indices, while at the same time lowering costs.
We take a closer look at how they do this.
What is Beta?
Beta is a measurement of the market relative risk of an individual stock. It describes a stock’s sensitivity to the movement of the broader stock market. For example, let’s say the beta of a broad stock index is expressed as 1.0. A stock with a beta of 1.0 suggests that it moves in line with the index. But if the stock has a beta of 1.2, this suggests it will move more than the market. Another way to think about this is volatility. A stock with a beta greater than 1 will move more than the market – up or down – is more volatile than the market, while a stock with a beta less than 1 will move less than the market and is said to be less volatile than the overall market.
What is Alpha?
Alpha is a term often used in conjunction with beta. While beta looks at the market risk, alpha focuses on characteristics that drive the performance. Specifically, it is a measurement of a strategy or a portfolio manager’s ability to outperform an index. Alpha is the result of active investing, and the higher the excess return the strategy generates, the higher the alpha.
How do alpha and beta relate to smart beta? Smart beta strategies are systematic active investment strategies, their goal is to deliver beta and while in addition generating alpha.
Smart Beta Explained
Smart beta – also called strategic beta or factor investing and a few other related terms – generally refers to rules-based approaches to investing. These strategies seek to capture specific factors such as value or quality as well as others, that active managers have commonly sought exposure to. Smart beta strategies do this while preserving the benefits of traditional indexed investments such as discipline, transparency, consistency and low cost.
Generating Alpha with Smart Beta
Smart beta strategies seek to capture specific performance factors to deliver an excess return over an index – similar to an active investment strategy. Smart beta strategies also aim to improve diversification and reduce risk. Investors can access multi factor investment strategies investing in suitably tailored ETFs, such as the Quality mix fund, ticker QMIX, the Quality Mix Fund, ETFs typically have lower expenses than a traditional actively managed fund, however multi-factor ETFs bring this benefit while delivering a similar return stream, thanks similar underlying investment factors sought.