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How Do You Define ‘Smart Beta’?

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Market Realist: What is your definition of smart beta? I think there is some variation in this definition depending on who you ask. As an innovator of indexing methodology, how would you explain smart beta?

Dave: For Nasdaq, smart beta is the screening, filtering, tilting, or adjusting of securities within a particular benchmark to create a new outcome-oriented benchmark, or new outcome-oriented strategy, that ties back to the benchmark but obviously creates a different risk and return profile, depending on the specified goal.

As I mentioned earlier, a classic example is equal weight. Take the stocks of a particular benchmark, and instead of market cap weighting, assign the same weight to every security and rebalance on a periodic basis. This creates a different risk-return profile than the parent benchmark, but it still retains a beta close to 1, so there’s a high correlation.

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At Nasdaq, we focus on a variety of areas such as value or growth stocks, dividend stocks, buybacks, momentum, and factors like risk or size. This is the basis of a lot of investment research and strategy which has been exploited by the active management community for decades, but can now, due to the proliferation of widespread data and technological improvement, be made available to the broader public via transparent indexes. It’s tough for active managers to compete because their information advantage has now disappeared. Going back to that general definition of screening, filtering, tilting, or adjusting securities to create a different outcome based upon the same benchmark, the industry is effectively taking away that advantage from active management and creating a whole new segment, which is smart beta.

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