Efficient Smart Beta

Published in The Journal of Investing, Spring 2016.

Executive summary

Smart beta should capture the premium associated with a factor, not merely display the factor exposure. After defining the factor and selecting a concentrated subset of stocks, the weighting step determines whether that premium is captured efficiently. The paper compares cap weight, equal weight, factor weight, and risk balancing across single-factor portfolios, isolating the weighting choice.

Cap weighting can inject unintended size exposure; factor weighting doubles down on the target factor and amplifies unintended tilts; equal weight looks neutral but still embeds hidden factor bets because risk is not explicitly managed. Risk balancing delivers slightly lower intended factor exposure but neutralizes unintended factor concentrations, producing more efficient premium capture over time.

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