Smart Beta


Many of you have asked about Smart Beta or Factor Investing lately. First, beta refers to the tendency of a stock’s returns to respond to changes in the market. Typically, the beta of a stock or security is measured against an index such as the S&P 500.

=1 A beta of 1 indicates that the security’s price moves with the market.
<1 A beta of less than 1 means that the security is theoretically less volatile than the market.
>1 A beta of greater than 1 indicates that the security’s price is theoretically more
volatile than the market.

If a stock’s beta is 1.1, it’s theoretically 10% more volatile than the market. On the other hand, if a stock’s beta is 0.75, it is theoretically 25% less volatile than the market.
So what is “smart beta?” Smart beta creates indices to compare to using a set of “factors” or characteristics of the stock or bond. It expands on the standard diversification we think of such as 80% to stocks and 20% to bonds or U.S. versus international.

Each factor carries its own potential “reward” for taking the risk. Of course, not every factor will outperform all of the time and adding factors such as these don’t guarantee a higher return. However, it creates different types of diversification in a portfolio.

Momentum: Stocks that outperform in the near term tend to continue to do so
Value: Cheap stocks tend to outperform expensive stocks
Market: Stocks tend to outperform bonds
Size: Small company stocks tend to outperform those of large companies
Quality: Stocks of high quality companies tend to outperform those of low quality companies
Low Volatility: Low volatility stocks tend to outperform high volatility stocks while offering better risk-adjusted returns
Interest Rate Risk: Bonds with longer durations or maturities tend to outperform shorter term bonds
Credit Risk: Bonds with lower credit quality tend to outperform bonds of high credit quality

If you would like to learn more about smart beta or factor investing, give us a call.

Sources: Symmetry Partners, Quarterly Insights and Understanding Smart Beta and Factor Investing