Smart Beta
Categories: Derivatives
A fish who knows their life is a pointless circling of a small tank.
Fund investing traditionally breaks into two camps: index investing and active investing.
Index investing involves putting money into a fund tied to a particular index, like the S&P 500. You are never going to outperform the market (or the particular sector you've invested in). However, you aren't going to get killed by management fees, and you're not in danger of underperforming either.
With active investing, an actual person picks stocks for the fund. Their goal is to outperform the general market. They pick stocks that will be winners and stay away from ones that will be losers. Theoretically, that sounds amazing...except that fund managers pick wrong all the time. Plus, even when they're right, some of the added gains get eaten up by fees.
Smart beta investing splits the difference between these two large categories of funds. It isn't a "dumb" index investment, which just tracks an index. The smart beta strategy seeks to outperform the market by weighting some stocks more heavily than others and staying away from clear losers.
However, these funds aren't actively managed either. The smart beta funds start with a particular index, but reweight it based on pre-set factors. Basically, a ranking system is set up, a set of criteria created, to judge stocks automatically. The funds aren't actively managed in the sense that a team of people are poring over spreadsheets and making decisions. Instead, decisions are made at the outset, and a computer does the rest. As a day-to-day endeavor, people aren't involved.
The structure of the smart beta funds keeps expenses low, closer to the rate of index funds. However, you get some potential for outperformance compared to the overall market.
Related or Semi-related Video
Finance: What is Beta?22 Views
Finance allah shmoop What is beta it's Volatility That's it
here's a stock chart reflecting the performance of a highly
volatile stock plus size manikins ink and here's A teen
t stock chart The last twenty years Yeah Whole lot
less volatile Eighteen t stock has left beta then p
s m so here's p s m mapped over the
s and p five hundred Gopi sm is about twice
a cz volatile Is the market here like on days
The markets up one percent p s m is up
two percent on days The markets down four percent p
s m is crushed down eight percent So you'd say
it has a beta relative to the s and p
five hundred of two point Oh or two acts So
the hammer this home let's do advanced math here So
if any given day the marks up one point two
percent has bit of two point Oh you'd expect p
s m to be up two point four percent and
same deal on the downside Yeah All right So what
gives a company high beta Well simply put uncertainty Some
companies have products in the pipeline Where the broader market
has a lack of certainty that buyers by the millions
anyway will want that product sort of the opposite of
coca cola Like what are the odds that buyers will
still want diet coke next year Yeah pretty good odds
but plastic manikins modeling extra large kimonos away Less certainty
So the company may end up awesome and ruling the
world Or it may end up being melted down for
spare parts Yeah Making newsman drone helicopter thing right Well
what else creates beta Well leverage or debt Some companies
have tons of cash Others have tons of debt of
company a is trading for one hundred bucks a share
and it has no debt and ninety five dollars a
share in cash Will The market is valuing the operations
of that company and only five bucks a share So
the operations could do awesome Or they could do terrible
and nobody's going to care Big web stock goes to
one hundred hundred five Ninety five Something like that big
No big deal So yeah i think about that The
value The operations could increase one hundred percent and be
worth five dollars more than the company's worth one hundred
Five bucks No big deal All right but what about
company b It has one hundred million box in ibadan
or cash flow or cash earnings and five hundred million
dollars in debt Well it trade today at eight times
ebitda calculated as eight times that hundred million figure Then
subtracting the five hundred million dollars in debt Well the
company would be valued at three hundred million dollars That
would be its market cap But what if it's new
product is likely to be loved and people get excited
about it and its operation suddenly get valued at twelve
times even thought instead of just eight While the math
goes like twelve times than one hundred million in cash
flow for one point two billion then you subtract the
five hundred million dollars in debt And that gets you
a market value for the whole company of seven hundred
million dollars So think about it The multiple of even
da being paid by investors went up just fifty percent
from eight to twelve But the stock market value of
this company went up well over one hundred per cent
In fact one hundred thirty three percent Why so much
More volatile or so much more beta Yeah leveraged debt
gasoline on the fire It can be great but when
things go the other way it can leave you feeling 00:03:10.49 --> [endTime] you know like a dummy