• Stonewood AM

Smart Beta Series: Episode 3 - The What & Why?

This month we continue in our series explaining the role of Smart Beta in the investment universe.

Smart Beta is a relatively new investment term and started out in the early 2000’s with the rise of Research Affiliates RAFI index creation. Which moved away from the traditional passive market capitalization weighted index investments to, for the first time, weighting holdings due to alternative characteristics or factors (in this case fundamental factors such as Price to Cash Flow, Price to Book Value) This gave rise to the fastest growing sector of asset management in the past decade... the rise of Smart Beta.

What is Smart Beta?

Smart Beta is often called the best combination of the advantages of both active and passive investment management. The objective of smart beta is to outperform the traditional market capitalization weighted passive index through an alternative weighting methodology. This has proven to be a very successful endeavor with almost all recognized Smart Beta factor strategies outperforming traditional passive strategies across asset class and jurisdiction over multiple investment cycles.

Smart Beta applies the same passive, formulistic approach to asset management that passive management does. In other words, once the index calculation formula is set up, it is for the most part set in stone and adhered to no matter what. This makes the methodologies and attribution of returns very transparent which is a positive for investors.

Where Smart Beta is similar to active management is that it does not rely on market cap weighting in order to achieve its returns, in fact many have called smart beta the commoditization of active management. In other words, it has taken the factors that active managers spend huge amounts of time and money identifying and instead tried to capture the same factor exposure in a formulistic fashion. You no longer must pay the traditional high fees associated with the black box of active management to get exposure to specific style of factor tilts in the world of investing. For example; a US Equity manager with a value style can easily be replicated with a US Equity Value smart beta index ETF. This means much of the alpha that has been captured or at least claims to be captured by active managers over and above the return of the market can now be captured as a fraction of the cost in easily traded ETF’s.

Smart Beta is a “catch all” description for any investment strategy that is not active but is also not market cap weighted passive and therefore covers a wide range of possibilities. In fact the amount of “Smart Beta” strategies that are now available exceed the universally agreed upon factors and styles that exist in the investment world.

Why Smart Beta?

Interestingly Smart Beta is a term that is yet to catch much fire in South Africa, but that is because the investment management and product development universe is very much dominated by the expensive active management firms that have ruled the roost locally for decades. They are unlikely to raise awareness about an offering that stands to steal market share and cannibalize on their existing strategies.

Again, to give an indication of the rise of Smart Beta globally as of the end of 2017 there were more than 1300 Smart Beta ETF’s across the globe, accounting for $680bn of global AUM. This is expected to grow to $1,2tn by the end of 2020 (according to Ernest & Young, 2017). Put differently, global investors are starting to see the benefits of getting access to many of the alpha seeking or beta optimization styles that they used to rely on active managers for in a lower cost, more accessible and tradeable and far more transparent way via Smart Beta ETF’s.

At the very least it is a matter of time before Smart Beta becomes a household alternative to active and passive management across the investment universe. We think the average South African investor and advisor should have access to and understand the benefits of Smart Beta as well as promote its inclusion in investment portfolios going forward and below is a quick summary of the pros and cons of this strategy.


  • Ability to outperform the market cap indexes and earn excess returns

  • Selecting of assets that suit current market conditions

  • Low Cost

  • Transparent

  • Easily traded via ETF’s


  • Factor or Style selection is still important and considered and active decision

  • Breadth of Smart Beta choices

  • Style/Factor drag/under-performance

  • Higher Cost than traditional passive

  • Lack of options available in RSA to local investors

  • Not widely available on LISPS (yet)

We expect Smart Beta and the use of Smart Beta philosophy to continue to rise as the global market increases in size and efficiency. As with our promise to advisors and clients, we will stay at the forefront of asset management philosophy and strategy implementation. We look forward the impact it will have on portfolio performance, efficiency and costs on investment solutions across the globe in the coming few years.

#SmartBeta #ETF

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