what is smart beta 
smart beta investing combines the benefits of passive investing and the advantages of active investing strategies the goal of smart beta is to obtain alpha lower risk or increase diversification at a cost lower than traditional active management and marginally higher than straight index investing it seeks the best construction of an optimally diversified portfolio in effect smart beta is a combination of efficient market hypothesis and value investing the smart beta investment approach applies to popular asset classes such as equities fixed income commodities and multi asset classes economist harry markowitz first theorized smart beta via his work on modern portfolio theory smart beta explainedsmart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices smart beta emphasizes capturing investment factors or market inefficiencies in a rules based and transparent way the increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk adjusted returns above cap weighted indices smart beta strategies seek to passively follow indices while also considering alternative weighting schemes such as volatility liquidity quality value size and momentum that s because smart beta strategies are implemented like typical index strategies in that the index rules are set and transparent these funds don t track standard indices such as the s p 500 or the nasdaq 100 index but instead focus on areas of the market that offer an opportunity for exploitation janiecbros getty imagesselecting smart beta strategiesthere is no single approach to developing a smart beta investment strategy as the goals for investors can be different based on their needs though some managers are prescriptive in identifying smart beta ideas that are value creating and economically intuitive equity smart beta seeks to address inefficiencies created by market capitalization weighted benchmarks funds may take a thematic approach to manage this risk by focusing on mispricing created by investors seeking short term gains for example managers may also choose to create or follow an index that weights investments according to fundamentals such as earnings or book value rather than market capitalization alternatively managers may use a risk weighted approach to smart beta that involves the establishment of an index based upon assumptions of future volatility for instance this may involve an analysis of historical performance and the correlation between an investment s risk relative to its return the manager must evaluate how many assumptions they are willing to build into the index and can approach the index by assuming a combination of different correlations smart beta popularityalthough smart beta funds typically attract higher fees than their vanilla counterparts they continue to remain popular with investors as of february 2019 77 new smart beta exchange traded funds etfs launched which accounts for roughly a third of all etfs that came to market in the past year according to factset data as reported by etf com smart beta funds also attracted a more significant increase in assets under management aum over the period growing at 10 9 compared to 4 3 for vanilla funds in total smart beta funds command 880 billion in total cumulative assets up from 616 billion in 2016 example of smart beta fundsthe following three etfs each use a different smart beta strategy seeking value growth and dividend appreciation respectively the vanguard value index fund etf shares etf vtv tracks the crsp us large cap value index its benchmark determines value using several fundamental ratios including price to book p b forward price to earnings forward p e historical p e dividend to price and price to sales the fund has 77 25 billion in aum as of april 2019 with net assets of 42 73 billion as of april 2019 the ishares russell 1000 growth etf iwf seeks to provide similar returns to the russell 1000 growth index the underlying selects components based on three fundamental factors price to book medium term growth forecasts and sales per share growth the vanguard dividend appreciation index fund etf shares vig aims to return similar investment results to the nasdaq us dividend achievers select index the fund selects firms that have increased their dividend payments for the past 10 years and market cap weights its holdings as of april 2019 vig has aum of 40 94 billion 