Smart Beta Can Be Smart But Is Not New

I held off writing about smart beta strategies as long as I could. The world, after all, is awash in such pieces. I couldn’t ignore it any longer, though, because virtually every piece I’ve read that’s critical of smart beta misses one fundamental point: The term “smart beta” may be new (and has certainly been effective from a marketing perspective) but the underlying strategies themselves are not.

Most of the debate has centered on the non-market-capitalization weighting schemes of smart beta funds. Historically, most index funds have weighted stocks by market capitalization (which simply is outstanding shares multiplied by price). Herein lies the difference between camps. One group believes that market-cap weighting is the only way to go while the other does not.

The reality, though, is that weighting stocks by metrics like dividends or company revenues is not much more than another way to tilt toward smaller stocks and value stocks, which we know have outperformed larger stocks and growth stocks over the longer term. Therefore, it’s perfectly reasonable to expect many smart beta approaches to outperform total market indexes over time as long as fees and execution costs are reasonable. However, overweighting small stocks and value stocks is hardly a new strategy. In fact, my firm has been doing this in client portfolios for about 20 years (unfortunately, we didn’t think to coin it “smart beta”).

And guess what? We have accomplished this by using mutual funds that are predominantly market-cap weighted. And this is my point. You can accomplish a tilt toward small and value by using either market-cap weighted funds or non-market-cap weighted funds. So what are we really talking about?

What Really Matters

What really matters is whether your overall portfolio is truly market-cap weighted, and whether that was done intentionally and intelligently. To keep the first part simple, if you hold any funds other than Vanguard Total Stock Market, Vanguard Total International Stock Market and Vanguard Total Bond Market (or similar broad market-cap weighted funds from other providers) in your or client portfolios, your portfolios are almost certainly not market-cap weighted.

If you found that your overall (and I want to emphasize “overall”) portfolio is not market-cap weighted, then you should ask yourself why. In our case, that’s because we generally want to tilt our client portfolios toward small and value stocks because we’re using those expected return premiums to improve our clients’ chances of reaching their goals. We believe our clients are capable of tolerating the tracking error associated with a size and value tilt. Therefore, at a very high level*, we’re right there with the smart beta folks from a portfolio composition point of view. This, again, is why I think the argument is generally more about semantics (and, of course, the seemingly endless demand for articles about investing) than anything else.

*I emphasize high level because I believe there are benefits to our approach relative to the fundamental weighting approach, but that’s for another article and another day.

This commentary appeared March 3 on

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Jared Kizer, CFA

Jared Kizer is the Chief Investment Officer for Buckingham Strategic Wealth. In 2008, Jared co-authored the book "The Only Guide to Alternative Investments You’ll Ever Need" with financial author Larry Swedroe. Jared has written several articles on such topics as retirement planning and investment policy. His work has been published in The Journal of Portfolio Management, Journal of Indexes and Jared has made appearances on local and national television, including Bloomberg Television. Additionally, he writes the blog Multifactor World. Jared holds a master’s degree in finance from Washington University in St. Louis.

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