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Introducing factors and smart beta

Factors - well known, well documented, well understood investment characteristics - are present in all portfolios. Factors are not new.

What is new is the way we access these investment ideas, such as through smart beta exchange traded funds (ETFs). Smart beta ETFs capture the power of factors, delivering them in a cost and tax efficient structure, revolutionizing the way investors access these historically rewarded investment ideas.

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    Smart beta is one of the fastest growing categories in the industry today; you can hardly open a newspaper without reading a headline about it. But what is smart beta?

    Well… let’s ask google.

    What is smart beta? There’s 71 million search results but the #1 result is from the Financial Times and it says, “Smart beta is a rather elusive concept in modern finance”.

    Q. Is smart beta really elusive?

    Well, it is to some, and that’s why we’re here today, to try to talk about the basics of smart beta and dispel some of the confusion. Smart beta seeks to enhance returns, improve diversification, and reduce risk for investors. It’s really a combination of what we think of as active and passive investing.

    It’s active in that it aims to outperform a cap weighted index after taking into consideration risk, return and cost. But it’s passive in that implementation is transparent and based on pre-set rules. Ideally those rules are objective enough that you can write them down and give them to somebody else to implement. It often comes in the form of an ETF or an index fund, and smart beta strategies capture many of the themes that have historically been present in traditional active strategies, but usually at a much lower fee.

    Q. How does smart beta do that?

    Well, to answer that question we have to understand “factors”.

    Factors are investment characteristics that help explain the risk and return behavior of a security. For example, stocks in the same industry tend to move together. Or bonds with a similar maturity would tend to move together. You might think of it as the DNA of a stock or a bond. So just like your DNA might govern your stubborn streak or the color of your eyes a stocks DNA its factors help explain a lot about its behavior. Now some, but not all factors have historically had a positive and persistent return over the long term and those are the ones we are most interested in. Smart beta ideas are also well understood by the marketplace.

    Let’s look at value.

    And I’m going to ask google. (Sara googles value) So the definition of value from the Webster’s dictionary is something that can be bought at a low or a fair price and put in an investment context what that means is that less expensive securities have historically outperformed their more expensive peers. So over the long-term, investors are rewarded for holding those lower profile potentially riskier names.

    So Smart Beta strategies try to target those ideas that are value creating, well understood, persistent and diversifying over time.

    Now, many of these concepts are not new ideas like value or quality have long puttered the stock selection framework for active managers. But what is new, is the idea that we can capture them with consistency and inexpensively in a passively oriented portfolio.

    And that is a pretty powerful idea. So there you have it. Smart Beta. It’s a smart way of thinking about investing beyond traditional active and passive.

Seek to manage risk

With iShares Edge Minimum Volatility ETFs, investors have the opportunity to gain broad market exposure, but with the potential for less risk.

Seek to manage risk

Seek to outperform

Factors are broad, persistent drivers of return that can help explain why stocks and bonds behave the way they do1. Today, investors can access factors strategies in low cost, transparent ETFs.

Seek to outperform