Smart beta funds are a modified versions of market index-based passively-managed funds such as the SPDR S&P 500 ETF (SPY). Smart beta fund indexes are tweaked to acquire active management factors such as value, quality, size, and growth. For example, the iShares MSCI USA Minimum Volatility ETF (USMV) and the PowerShares S&P 500 Low Volatility ETF (SPLV) are smart beta funds with indexes that select stocks based on volatility. Similarly, the Powershares Dynamic Pharmaceuticals ETF (PJP) and the PowerShares Dynamic Biotech & Genome ETF (PBE) are sectoral smart beta funds. Some smart beta funds are based on dividend-providing stocks, such as the iShares Select Dividend ETF (DVY) and the FlexShares Quality Dividend ETF (QDF).
The CBOE Volatility Index
USMV’s top holdings are AT&T (T), McDonalds (MCD), and Verizon Communications (VZ). Top holdings of similar ETF SPLV are Plum Creek Timber (PCL), Marsh & McLennan (MMC), and Verizon Communications (VZ). The CBOE (Chicago Board Option Exchange) Volatility Index (VIX) is an index that measures the overall implied volatility of the market. The VIX helps investors estimate the future movement or volatility of a particular stock or index as a whole. Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations (an increase or decrease in a stock’s price) over time. Normally, implied volatility increases when markets are down and vice versa. Implied volatility rises during critical situations and is under control during normal market activity.
The VIX versus smart beta funds
In this series, we’ll discuss the workings of different smart beta funds with respect to the VIX. By comparing smart beta funds with the VIX, we can understand the effect of volatility on their performance. The VIX represents market movement in the upcoming 30-day period, which has an enormous impact on the current flow of the market.