FRM Part II · FRM Exam Part II · Factors
A pension fund's investment committee is reviewing a smart beta equity product that weights stocks by book value, sales and dividends instead of market capitalization. Which feature of this product most accurately describes how it differs from a cap-weighted index?
Fundamental-weighted smart beta decouples weights from market prices, so it avoids the automatic overweighting of stocks whose prices have risen. This creates an implicit value tilt and contrarian rebalancing. It does not guarantee lower volatility, remove value exposure, or require short selling.
- AIt removes the link between a stock's weight and its price, reducing the tilt toward overvalued stocks implicit in cap weightingCorrect
- BIt guarantees lower volatility than the cap-weighted index in every market regime
- CIt eliminates all exposure to the value factor
- DIt requires continuous short selling of large-cap stocks
Explanation
Fundamental weighting uses accounting measures rather than price, so weights do not rise automatically when a stock's price rises. This implies a natural value tilt and contrarian rebalancing. It does not guarantee lower volatility, and it carries value exposure rather than eliminating it. It is also long-only.
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