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10 top smart-beta stocks

Nicholas Grove  |  09 May 2014Text size  Decrease  Increase  |  

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Nicholas Grove is a Morningstar journalist. This article originally appeared on Morningstar.com.au on 6 March 2014.


Investors will have heard or read about "smart-beta" strategies and may have scratched their heads, wondering what they are actually all about.

As Morningstar fund research analyst Kathryn Young explains, smart beta refers to strategies that seek to improve on traditional index-tracking investments.

"Traditional index funds replicate an index that weights stocks by their market capitalisation. That makes stock price a primary determinant of the stock's prominence in the portfolio," she says.

"In contrast, 'smart-beta' strategies use other factors to weight stocks in the portfolio. Such factors are often fundamental in nature, such as sales and dividends, but can also be market-based, such as volatility."

Recent figures have illustrated the value of smart-beta strategies in investment portfolios, with a smart-beta index beating both Australia's main market-cap weighted index and many active fund managers on a total-return basis in 2013.

In what was a standout year for active funds, the median manager returned 23.2 per cent over calendar 2013, according to a recent survey, compared to the 20.2 per cent return achieved by the S&P/ASX 200.

But according to exchange-traded fund (ETF) provider BetaShares, eclipsing both was the FTSE RAFI Australia 200 index, which returned 25.5 per cent over calendar 2013.

This performance is supportive of the longer-term performance of this index, which has outperformed the S&P/ASX 200 in 15 out of the last 20 years, BetaShares said.

As BetaShares explains, this index is a "fundamental index" that is designed to provide investors with exposure to the top 200 companies listed on the ASX, weighted in a way that reflects their economic footprint rather than simply their market capitalisation.

The index has been built using the RAFI Fundamental index methodology, which aims to produce superior long-term performance compared to traditional market-cap-weighted indices.

It seeks to do this by improving on some of the limitations of market-cap-based methodologies, while still maintaining the benefits of passive investment such as lower turnover costs, broad economic representation and a transparent, rules-based process, BetaShares says.

Rather than simply using market capitalisation of companies in order to weight constituents - which may often result in investors being overweight relatively expensive stocks and underweight relatively inexpensive stocks - the RAFI Fundamental index approach uses four fundamental measures of company size to determine index weights.