Is Smart Beta a Smart Strategy for You?

Traditional investment indexes such as the S&P 500 are weighted based on market capitalization, the value of a company’s total outstanding stock. This means the largest companies in the index may have much greater influence on index performance than smaller companies.

For example, the 10 largest companies in the S&P 500 account for more than 18% of the index’s performance, as opposed to about 2% if every company were weighted equally.

Funds that track market-weighted indexes may be the most direct way to participate in broad market performance, but there has been increasing interest in an alternative indexing strategy called smart beta (also known as strategic beta or factor-based investing). More than 100 smart beta exchange-traded funds (ETFs) were launched in 2016.

Shifting the weight
Smart beta funds use factors other than market capitalization to select and weight investments in order to track an existing or newly created factor-based index. Some factors that might be considered are momentum, risk, volatility, earnings, growth potential, price-to-book value, dividend growth or yield, cash flow, or equal weighting of all securities. (Traditionally, beta is a measure of an investment’s volatility, but smart beta indexes may or may not consider volatility).

The idea of using factors to select investments is not new. For example, numerous indexes track stocks perceived to have higher growth potential or to offer greater value. However, even if the investments are selected based on a factor, such indexes are typically still weighted based on market capitalization. Though investment tracking such indexes might be considered in the smart beta category, a true smart beta growth or value index would be selected and weighted based on a measure of growth or value.

Long-term strategy
The goal of smart beta strategies is to outperform the broader market, but even if a factor does outperform during one market cycle, it may underperform in the next cycle. This is one of the fundamental challenges not only of smart beta, but of any strategy that attempts to outperform the market. Even within a given cycle, a successful strategy may become neutralized or unsuccessful as other investors adopt the same strategy.

Because of these limitations, smart beta fund are generally not wise for short-term investors, but they may be appropriate as a long-term strategy in a diversified portfolio.

Investors should carefully consider the investment objectives, risks, fees and expenses before investing. For this and other important information please obtain the investment company fund prospectus and disclosure documents from your Advisor. Read this information carefully before investing. Indices mentioned are unmanaged and cannot be invested into directly.

 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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