In this article, Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021) presents the concept of Smart beta 2.0, an enhancement of the first generation of smart beta strategies.
The structure of this post is as follows: we begin by defining smart beta 2.0 as a topic. We then discuss then the characteristics of smart beta 2.0.
“Smart beta 2.0” is an expression introduced by Amenc, Goltz and Martellini (2013) from the EDHEC-Risk Institute. This new vision of smart beta investment intends to empower investors to maximize the performance of their smart beta investments while managing their risk. Rather than offering solely pre-packaged alternatives to equity market-capitalization-weighted indexes, the Smart beta 2.0 methodology enables investors to experiment with multiple smart beta indexes to create a benchmark that matches their own risk preferences, and by extension increase their portfolio diversification overall.
Characteristics of smart beta 2.0 strategies
The main characteristic of smart beta 2.0 strategies compared to smart beta 1.0 strategies is portfolio diversification.
If factor-tilted strategies (i.e., portfolios with a part specifically invested in factor strategies) do not consider a diversification-based goal, they may result in very concentrated portfolios in order to achieve their factor tilts. Investors have lately started to integrate factor tilts with diversification-based weighting methods to create well-diversified portfolios using a flexible strategy known as Smart beta 2.0 (EDHEC-Risk Institute, 2016).
This method, in particular, enables the creation of factor-tilted indexes that are also adequately diversified by using a diversification-based weighting scheme. Because it combines the smart weighting scheme with the explicit factor tilt (Amenc et al., 2014), this strategy is also known as “smart factor investment”. In order to achieve extra value-added, investors are increasingly focusing on allocation choices across factor investing techniques.
The basic foundation for the smart beta has been substantially outstripped by its success with institutional investors. It is clear that market-capitalization-weighted indices have no counterpart when it comes to capturing market fluctuations (Amenc et al., 2013). Even the harshest detractors of market-capitalization-weighted, in the end, use market-capitalization-weighted indices to assess the success of their own new indexes (Amenc et al., 2013). In fact, because smart beta strategies outperform market-capitalization-weighted indexes, the great majority of investors are likely to pick them. While everyone believes cap-weighted indexes provide the most accurate representation of the market, they do not always provide an efficient benchmark that can be used as a reference for a strategic allocation. It’s worth noting that smart beta 2.0 seeks to close the gap in terms of exposure to factors from the first generation, but it doesn’t guarantee outperformance over market-capitalization-weighted strategies (Amenc et al., 2013).
Why should I be interested in this post?
If you are a business school or university undergraduate or graduate student, this content will help you in understanding the evolution of asset management during the last decades and in broadening your knowledge of finance.
Smart beta funds have become a hot issue among investors in recent years. Smart beta is a game-changing invention that addresses an unmet need among investors: a higher return for lower risk, net of transaction and administrative costs. In a way, these strategies (smart beta 1.0 and then smart beta 2.0) have created a new market. As a result, smart beta is gaining traction and influencing the asset management industry.
Related posts on the SimTrade blog
▶ Louraoui Y. Factor Investing
▶ Louraoui Y. Origin of factor investing
▶ Louraoui Y. Smart beta 1.0
▶ Louraoui Y. Size Factor
▶ Louraoui Y. Value Factor
▶ Louraoui Y. Yield Factor
▶ Louraoui Y. Momentum Factor
▶ Louraoui Y. Quality Factor
▶ Louraoui Y. Growth Factor
▶ Louraoui Y. Minimum Volatility Factor
Amenc, N., F., Goltz, F., Le Sourd, V., 2016. Investor perception about Smart beta ETF. EDHEC-Risk Institute working paper.
Amenc, N., F., Goltz, F., Martellini, L., 2013. Smart beta 2.0. EDHEC-Risk Institute working paper.
Amenc, N., F., Goltz, F., Martinelli, L., Deguest, R., Lodh, A., Shirbini, E., 2014. Risk Allocation, Factor Investing and Smart Beta: Reconciling Innovations in Equity Portfolio Construction. EDHEC-Risk Institute working paper.
About the author
The article was written in September 2021 by Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021).