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FRM Part II · FRM Exam Part II · Factors

A pension fund replaces a market-cap-weighted equity index fund with a 'smart beta' fund that selects and weights stocks by fundamental characteristics such as book value and cash flow. Which statement best describes the main rationale for this approach?

Smart beta aims to capture systematic factor premia such as value through transparent, rules-based weighting schemes instead of market-cap weights or discretionary stock picking. It does not remove market beta, guarantee alpha, or avoid rebalancing turnover.

  1. AIt seeks to capture systematic factor premia, such as value, through rules-based, transparent weighting rather than manager discretionCorrect
  2. BIt eliminates all exposure to market beta by construction
  3. CIt guarantees positive alpha net of fees through security-specific forecasting
  4. DIt reduces turnover to zero by holding securities in constant proportions

Explanation

Smart beta strategies are rules-based and transparent, and aim to harvest factor risk premia through alternative weighting schemes. They still carry market exposure, do not guarantee alpha, and generally require rebalancing.

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