Smart beta is being used by investment institutions to address multiple requirements and to produce different types of investment outcomes. As market participants’ growing interest in smart beta is driven by risk- and return-based considerations, we provide examples of how smart beta indexes are being used by market participants in both these areas. Finally, we illustrate investors’ current use of smart beta through case studies involving FTSE Russell clients.

What is smart beta?

Smart beta is a catch-all term that covers a wide range of systematic, index-based investment strategies across asset classes. Smart beta indexes select and weight their constituents differently from the standard methodology of capitalization-weighting (i.e., apportioning index weights to securities according to their market capitalization).

FTSE Russell defines smart beta indexes as encompassing two indexing strategies:

  • Alternatively-weighted indexes, designed to address perceived concentration risks in capitalization-weighted indexes or to reduce index volatility;
  • Factor indexes, designed to replicate factor return premia in a transparent, rules-based and investable format.

There is an overlap between these two categories: alternatively-weighted indexes have factor exposures. However, these exposures may not be stable over time and are a by-product of the index design (rather than its primary objective).

Two categories of smart beta indexes

Who uses smart beta?

Smart beta assets under management seem likely to increase significantly over coming years, according to the FTSE Russell 2016 survey  of global asset owners, with an estimated US$2 trillion under management. 52% of European institutions and 28% of North American institutions have a current allocation to smart beta.

Seventy-six percent of investors with a current smart beta allocation and evaluating smart beta expect to increase their percentage allocation in the next 18 months. And over half of those asset owners without a smart beta allocation who are evaluating smart beta expect to make an allocation within the same 18 month period.

For those with an existing allocation to smart beta, satisfaction levels are high. 74% of asset owners with a smart beta allocation report being satisfied or very satisfied with smart beta’s ability to deliver intended investment outcomes, an increase from 61% in the 2015 survey.

Usage outlook (next 18 months) for asset owners

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