Smart Beta ETFs are a relatively new approach to index investing that utilizes a rules-based, systematic approach for selecting stocks from a particular index. Smart Beta ETFs allow an investor to gain exposure to the overall return of an index, but also give them the ability to incorporate alternative factors into their portfolio construction.

The standard form of index investing is known as “passive investing”. This form of investing follows an index, using the same weighting that the index typically holds on its underlying stocks. This approach is simply a low-cost way of investing in a large basket of stocks.

Smart Beta ETFs, however, are an alternative form of index investing that utilizes a rules-based and systematic approach for selecting stocks from an index. Smart Beta ETFs allow investors to gain exposure to the overall return of an index, while also incorporating certain alternative factors into their portfolios.

Common types of Smart Beta ETFs include strategies that are equally weighted, fundamentally weighted, factor-based, and low volatility. An equally weighted Smart Beta ETF gives each security in the index the same weight, regardless of the size of the company or traditional index weighting. Fundamentally weighted Smart Beta ETFs are constructed using fundamental factors, such as earnings or cash flows, instead of the traditional market capitalization approach. Factor-based Smart Beta ETFs choose stocks that are uniquely exposed to certain market factors such as value, momentum, or low volatility. Finally, low volatility Smart Beta ETFs screen for stocks that have lower historical volatility, giving investors reduced downside risk.

Smart Beta ETFs offer several benefits. One of the primary benefits is that they allow investors to access certain market factors or strategies that may not be available through traditional index investing. Furthermore, Smart Beta ETFs offer lower fees compared to actively managed strategies. Finally, the rules-based approach to selecting stocks from an index makes Smart Beta investing much more transparent compared to active strategies.

Overall, Smart Beta ETFs are becoming an increasingly popular option for investors who want to capture the return of an index, but also incorporate some degree of customization at a low cost.