What the heck is smart beta anyway?

Alternative indexing strategies--seen as a way to boost returns and manage risk--are generating lots of buzz.

Adam Zoll 28 October, 2013 | 11:03PM
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Question: I keep hearing the term "smart beta" in discussions about investing. Can you explain what it is?

Answer: So-called smart beta strategies, also known as factor-based or alternative indexing, were a hot topic at the recent Morningstar ETF Invest Conference in Chicago and have garnered quite a bit of attention lately as a lower-cost way for investors to obtain access to specific investment strategies traditionally available only through actively managed funds.

Most investors already have some familiarity with index-based investing, in which a mutual fund or exchange-traded fund simply replicates all the holdings of a given index. The most widely used indexes, such as the S&P/TSX Composite or the S&P 500, are capitalization-weighted, meaning that they, and the funds that track them, allocate holdings based on each company's market capitalization. Thus, bigger companies make up a bigger percentage of the portfolio while smaller companies make up a smaller share.

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Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com

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