Slowly, very slowly the concept of smart-beta is beginning to creep into the consciousness of the investment community, though it is probably still a long way from penetrating the retail investment world.
Like many new ideas it suffers from, or perhaps enjoys, a multitude of definitions and descriptions. So, at the risk of muddying the waters even more, here is another.
It was probably around early 2009 that the phrase Smart-Beta began to be used. Before that the approach had been described as fundamental tracking or fundamental indexing. In a brilliant example of why English is such a popular language the strength of the anglo-saxon preference for short words over long ones soon meant that the shorter description triumphed over the long ones.
Using beta in the label immediately helps us to understand what the product is offering. Technically beta is a measure of the volatility of a stock relative to the index it is part of. So a stock with a beta of 0.9 is 10% less volatile than the market; it goes down 10% less when the market falls and lags the market by 10% when it rises. The market, in the form of an index, of course has a beta of one and this has allowed the term to morph into shorthand for the behaviour of the market as a whole.
Beta as slang for the market is therefore quite handy. But what about the smart bit? The market is normally defined as the aggregate capital value of all its constituents. Changes in this value tell us what the market is doing over various periods of time and this is the index conventional market capitalisation based tracker funds use.
The market capitalisation, or price, of a company, calculated by multiplying its share price by the number of shares in issue, is really just a measure of its popularity. There is no direct arithmetic link to any of its financial characteristics such as book value or profitability. Many investors accept that, in broad terms, the market is pretty good at pricing stocks. In other words there is grudging acknowledgement that the Efficient Market Hypothesis largely holds true.
Nonetheless, anyone who has watched capital markets for any length of time knows full well that investors can get too enthusiastic, or too depressed,…
About the Author
Rob Davies
0 comments
