Smart Beta

Evolving Smart Beta

Smart beta strategies can also be described as portfolios that tilt toward various, or combinations of, equity factors.

Smart Beta Viewed as a Factor Framework

Today smart beta is often being viewed through the lens of risk and return drivers—or factors. These are investment characteristics that help explain the behavior of a security. Driven by risk preferences and or behavioral anomalies, factors have been shown to generate excess returns over long time horizons. Some factors are robust, whereas others appear to be the result of data mining.

Academic literature provides useful guidance on how to determine whether a factor truly contains a return premium.

The factor premium does not materially change because of minor variations in the factor definition or construction.

The factor is robust over time.

  • Even after numerous database revisions and extensive out-of-sample data testing, the factor retains its persistence.
  • The factor is vetted, replicated, and debated over decades in top academic journals.

The factor works across geographies.

The persistent factor premium can be credibly explained, supported by

  • financial theory or macro risk exposures.
  • a deep-rooted behavioral bias present in a meaningful fraction of investors.
  • an institutional or structural feature that cannot be easily changed.

The equity factors that appear to be most robust over time and across countries are
Market           Value          Momentum          Low Volatility

Smart Beta Beyond Equities

The investment industry continues to evolve the concept of smart beta beyond the equity asset class. Commodities and fixed income are two of the more popular asset classes now attracting smart beta strategies.

Unlike in the equity space, weighting in traditional commodity indices are only loosely linked to price. These do however suffer from naive construction rules that lead to poorly diversified portfolios, negative roll returns and ultimately results in a return drag.

To improve on the performance of existing indices, smart beta commodity strategies tap into systematic sources of return, namely roll yield—both across different commodities and along the term structure of contracts—and momentum. These are the primary drivers of excess returns in commodity investing.

Fixed Income
Traditional corporate bond indices weight their constituents based on the amount of debt outstanding. This means that the most indebted issuers have the largest index weights, potentially overexposing investors to firms with poor credit quality and high corporate leverage (based on debt to assets) without necessarily improving returns.

Sovereign bond indices are weighted by the market value of outstanding debt, where countries with the most debt receive the largest weights. The quality of these debts and the countries’ ability to service and ultimately repay them, is often not proportional to the size of the debt burden.

Applying the principles of smart beta to fixed income means emphasizes debt-service capacity, severing the link between outstanding debt and portfolio weight. This approach avoids overexposure to companies or countries with high debt burdens and credit risk.


“The smart beta movement makes it particularly important to understand the zoo of factors and how best to capture factor premia in an equity portfolio.”

Jason Hsu

Latest Publications

How to Invest

Access our strategies through leading asset managers around the world.