Smart Beta 2.0.

Summary Alternative equity indexes are likely to outperform traditional cap-weighted indexes over the long term, research results show that such smart beta strategies are exposed to several types of risk, including systematic risk (e.g., factor tilts), specific risk (related to the assumptions and inputs of a strategy), and relative risk (i.e., the risk of potentially severe underperformance) compared to cap-weighted indexes that can last for extended periods of time. Smart beta can play an important role in institutional investors’ allocations, but only at the price of implementing a genuine risk-management process. This article discusses a new approach to smart beta investing (Smart Beta 2.0) that not only deviates from the default solution of using market capitalization as the sole criterion for weighting and constituent selection, but also analyzes and manages the risks of such deviations.