Content provided by Joe Smith, CFA, Senior Market Strategist

Smart beta ETFs continue to dominate the financial news as more investors and asset managers grapple with the continued shift from active to passive investing. Despite this movement, smart beta investing is still widely unknown, and there is little understanding about what it actually means. At CLS, we are heavy users of smart beta ETFs. We employ them primarily to gain access to return premiums, such as value, size, momentum, quality, and minimum volatility.

Smart beta ETFs aim to marry two differences between active and passive investing (fees and exposure) by screening for stocks the way an active manager would. The only difference is smart beta ETFs use rules-based methodologies to find stocks that meet an investor’s target investment exposure without the need for human judgement.

To illustrate this point, let’s take a look at the suggested holdings for both the MSCI USA Index and a hypothetical smart beta index targeting value stocks within the same index universe. The MSCI USA Index is simply a market-cap-weighted index, while our hypothetical smart beta index targets stocks that score with high exposure to the value factor.

So what do the results tell us? Not only does the smart beta index have less in common with the market-cap index in terms of the top names held in the portfolio, but the stocks clearly score much higher on the desired exposures (in this case, value) than the market-cap index. In effect, a smart beta index captures the essence of a typical active manager’s intent, but with transparent rules that re-base a traditional index along an investor’s desired exposure.

The key takeaway is smart beta investing is not necessarily new, but it’s an exciting twist to exposures investors have long accessed through active managers and their stock-picking abilities. Smart beta ETFs provide additional value for investors, including those in CLS portfolios, by providing a more cost-effective approach to accessing return premiums that deliver value for the long haul. Just one of the many reasons I love being smart beta invested!