You might have seen ads for “Smart Beta”. If you are interested learning in what Smart Beta is, you first have to start with what it isn’t.

What Smart Beta Is Not

About 50 years ago, some powerful ideas were introduced that revolutionized investing. The basic idea is that very, very few people are going to beat the market. So an investor should just buy a slice of the market as a whole.

You hear about terms like
* S&P 500
* Index Fund
* Passive Investing
* Jack Bogle
* Vanguard
* Beta
* Market Weighted
* Modern Portfolio Theory
* Efficient Market Hypothesis
* Capital Asset Pricing Model (CAPM, pronounced “CAP. EM.”)

All this culminated in a concept called indexing: an investor just buys all the stocks in a well known index such as the S&P 500. And then leaves it alone.

Even Warren Buffet has said that, when he dies, he wants all his money put in an index fund:

My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers. – Warren Buffett

What Is Smart Beta?

Smart Beta says, “Yes, buy the market like indexing, but, buy less of some stocks and more of others”. How does Smart Beta decide on what to buy more of? Smart Beta adds a rigorous academic tweak, taking into account some factors that have historically identified better companies to invest in. A Smart Beta portfolio will hold more stocks of companies that:

  • Are smaller
  • Own physical assets like factories or land
  • Are stingy with investments
  • Generate higher profitability

Tweaking a portfolio based on those factors is the “Smart” in “Smart Beta”.

Example of Smart Beta

Imagine the S&P 500 holds two stocks: Acme Works and Zed Commerce. Acme is worth $100 million, and Zed is worth $50 million. Classic indexing (aka market-weighting) would hold $100 worth of Acme stock for every $50 worth of Zed.

An investor using Smart Beta techniques would say, “Zed is more profitable… it’s smaller… it’s stingier with investments… it owns factories instead of Acme just being a services company”. Based on those factors, the Smart Beta investor would calculate how much more of Zed to hold than just the market-weight… ending up with perhaps only $98 of Acme for every $52 of Zed.

History of Smart Beta

Two academics who pioneered these ideas were Eugene Fama and Kenneth French. One of their students, David Booth, founded an asset management firm called Dimensional Fund Advisors to take advantage of these ideas. Dimensional is now a top-10 asset management firm with $460 billion in assets under management (AUM).

Some of the terms you’ll hear that usually indicate Smart Beta include:

  • Fundamental Factors
  • Multi Factor Model
  • Three Factor Model
  • Momentum
  • ActiveBeta®
  • Fama-French

The Upshot: The Best Robo-Advisors For Smart Beta

FSRankings doesn’t take a stand on whether Smart Beta is a good idea or not. We aren’t as smart as all the academics doing research on this topic! But if you are interested in investing your money with a robo-advisor focused on Smart Beta, you have a few options.

Charles Schwab Intelligent Portfolios relies heavily on Smart Beta Funds. With a $5,000 minimum investment, this is a great option.

Asset Builder is a robo-advisor that offers funds from Dimension Fund Advisors, the original innovators in the space. If you can invest their $50,000 minimum, Asset Builder is a low cost way to access funds created by Dimensional Fund Advisors.

Wealthfront recently announced its own form of Smart Beta on its blog called Advanced Indexing for clients with at least $500,000 invested. Wealthfront offers the service at no additional cost to its annual 0.25% advisory fee. Unlike many other Smart Beta strategies, Wealthfront notes that its strategy uses tax-loss harvesting and combines multiple factors such as dividend yield, market beta and volatility.


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