First of all, there is a lot of terminology in the industry which pretty much refers to the same philosophy; it can go by Smart Beta, Strategic Beta and lately Factor Investing seems to be catching on in the investing circles
Factor Investing has been around for many decades, but with ETF wrapper it has become accessible to many retail clients. The traditional approach to buying a diversified basket of assets in the hope that their low / non-correlation will protect the investor in times of market decline has been broken as witnessed recently during the financial meltdown of 2007-2009. On the other hand Factor Investing helps the investor in understanding the main drivers of return. By choosing these factors the investor can potentially achieve a higher risk-adjusted return.
These funds, offer a relatively new twist to the traditional indexing methodology of using the market capitalization weighting the index constituents. It is, in essence, a hybrid between active and passive strategies. Passive because it follows an index and active cause it applies filters within an index to select companies. So in a sense, they pick and choose the companies that comprise the index. The screens could be based on many factors. They tend to be more transparent than active funds. These indexes overlay analysis of factors, such as:
- Dividend (growth or yield)
- Quality/Fundamental (balance sheet factors)
- Equal Weight Indexes
Even within Smart Beta Strategies, one could use single factor or multi-factors tilts to construct portfolios.