A Taxonomy of Beta Based on Investment Outcomes

Abstract

The traditional active vs passive debate has been shaken up by the emergence of “smart beta” strategies. As the population of these products has exploded, the quest to differentiate among them has focused on portfolio construction techniques rather than what actually matters, namely investment outcomes. Yet it is crucial for asset owners considering a smart beta allocation to understand the wide dispersion of key performance results due to the starkly different investment approaches employed by these strategies. The purpose of this white paper is to redirect the conversation back where it belongs.

Our taxonomy of smart beta strategies, supported by a comprehensive analysis of simulated historical returns over three decades covering both developed and emerging markets, distinguishes between three stated portfolio construction objectives (Enhanced Diversification, Factor Investing and Fundamental Weighting) and two investment outcomes (Core Exposure and Style Investing). The investment outcomes are characterized by performance patterns as well as qualitative considerations such as benchmark sensitivity, turnover levels, and underlying beliefs about market inefficiencies and the merits of broad diversification.

Keywords: smart beta, factor investing, style investing, core equities, investment outcomes

JEL Classification: G10,G11,G12