It’s a Bird, It’s a Plane, It’s Smart Beta

Speaking of hot topics, the investment community is abuzz with a new term: smart beta. The term is gaining increasing popularity and the current edition of Institutional Investor magazine has a lengthy article (and series of ‘sponsored content’ pages) on the topic.

Despite the popularity of the phrase in the industry right now (I do think it’s a fad, but I will get to that in a minute), let me define it for you by way of a very brief history lesson.

Prior to the 1950s, there were no indexes that tracked the performance of the overall stock market. The Dow Jones averages have been around since the late 1800s, but they have a limited number of stocks and the weighting scheme is peculiar at best.

Indexes were initially constructed just to see how the overall market was doing, so it made sense to simply weight the indexes by the size of the company, or, in financial jargon, the market capitalization.

It wasn’t for another few decades that academics realized that indexes routinely beat most managers and that it made sense to simply invest in a low-cost fund that mimicked the index.

Within another decade, academics, index providers and investors realized that there are many ways to slice and dice the market, not just by the size of the companies.

We’ve written about these other weighting strategies before, whether it was by the relative cheapness of a stock (value), the price activity of a stock (momentum) or the creditworthiness of a bond (credit).

There is nothing new about this, but a clever group of marketers have started to refer to the non-market capitalization indexes as ‘smart beta.’

In some ways, I am happy to see the term smart beta gaining in popularity because it promotes things that we like at Acropolis: diversified, low cost, transparent and rules-based strategies.

At the same time, a lot of the ‘new’ ideas are nothing more than old ideas with a different marketing spin and a higher price. A lot of the strategies that we have seen are nothing more than value or credit at two or three times the cost of the products that we use.

One of the funny elements of the smart beta evolution is to see firms jockeying over the term itself. Other names that apply to the same concept are: Sensible Beta, Strategic Beta, Scientific Beta or Alternative Beta.

Our friends at AQR, who could easily be classified as smart beta providers even though they don’t use the term, offered a few other names in jest: Clever Beta, Ingenious Beta, Pensive Beta and, my favorite, Ennui-Stricken Beta.

So, if you hear someone pitching smart beta, we’ve been invested in the strategies for years but aren’t so nutty about the adjectives.