"Smart beta," "alternative beta," "enhanced indices," "fundamental indices" "quantamental indices"-- there's a list of monikers to describe the expanding middle ground between active and passive funds. The need to define this space, to measure it and to police it has grown and will continue to grow.
Strategic beta aims to improve on traditional indexing, yet retain its transparency, low turnover, tax efficiency and low fees. It is one of the fastest-growing sectors in the fund industry and is popular in others markets too, such as Australia.
Active managers consider many factors but ultimately judgment is key. In contrast, on the passive side, traditional indices use rules, not judgment. The primary rule is market cap. Even if a company is expensive, if it's big, it should loom large in a market-cap-weighted index.
Strategic beta lies somewhere in between -- it is rules-based but goes beyond market cap. Other factors drive portfolio make-up, such as value, momentum, quality, volatility or income.
A brief historical detour
The proverb "There is nothing new under the sun" applies to this "new" corner of the asset-management arena. Academics distilled investment returns into their component factors decades ago. And others, most notably the eponymous founder of Barr Rosenberg Associates, had recombined these basic drivers of investment returns into investable products. In fact, Rosenberg's "bionic betas" landed him on the cover of the May 1978 issue of Institutional Investor magazine.
So why is this time different?
There have been major advances in information and investment technology since the mid-1970s that have given asset managers the horsepower necessary to efficiently manage more-complex index strategies, to repackage them into the newest generation of strategy-delivery vessels (such as ETPs), and to deliver them at a low cost to investors.
The past four decades have also been marked by steady secular growth in index investing. Since the first index fund was launched in 1975, the portion of U.S. mutual fund and ETP assets accounted for by index-tracking products has grown from nothing to nearly 30% today. All told, the investment world of today is far more ready for these sorts of strategies than it was 40 years ago, when some people, as John Bogle has reported, were calling the concept of indexing "un-American."
Next: Why Morningstar refers to it as strategic beta
