What are Smart Beta ETFs?

Most equity ETFs weight the companies they hold in proportion to their size – the larger the company the more stock of the company the ETF holds – this is called ‘market capitalization’ weighting.

Smart Beta ETFs take different approaches to decide how much of a particular stock to own and do not rely on the size of the company to determine the amount they hold. Some of the more common types include:

Equal weighting

This approach allocates the same amount to every stock, regardless of how big the company is. Because movements in stock prices will eventually cause these allocations to move away from equal, the weights are reset back to equal at a regular rebalance.

Risk weighting

Equal Risk Contribution

The amount of each stock in the index is based on a calculation of how much volatility they contribute, so that they all contribute the same – this essentially gives greater weight to less volatile stocks but does not try to limit the total risk of the index.

Minimum volatility (or minimum variance)

The stocks are weighted in a way that minimizes the expected volatility of the overall portfolio – this essentially means stocks with lower volatility and smaller correlations with other stocks are given a greater weight.

Fundamental weighting

The weight of each stock is based on a combination of accounting metrics, like book value, sales, earnings or dividend yield.

Price weighting

The weight of each stock is based on its price, so basically tracking the index involves buying one share of each stock.

Sounds complicated? That’s because it is. Only invest in a Smart Beta ETF if you understand what it does and how it can help you build your wealth.

Want to know more? Take a look at the Smart Beta ETFs available to buy in your region.