FRM Part II · FRM Exam Part II · Factor Theory
A portfolio manager at a pension fund is comparing a traditional market-capitalization-weighted index fund with a smart beta product that tilts toward stocks with high book-to-market ratios. Which statement best describes the main purpose of the smart beta product relative to the cap-weighted index?
Smart beta aims to harvest systematic factor risk premia, such as value, through rules-based, transparent, low-cost strategies that deviate from cap weighting. It is not discretionary stock picking, does not remove market beta, and does not simply replicate the market portfolio.
- ATo obtain systematic exposure to a rewarded factor premium through a rules-based, transparent strategyCorrect
- BTo generate idiosyncratic alpha by discretionary stock picking that is uncorrelated with all factors
- CTo eliminate all market beta so that returns are independent of equity market movements
- DTo replicate the market portfolio at lower cost by holding fewer securities
Explanation
Smart beta strategies are rules-based and transparent and aim to capture a factor risk premium (here value) in a systematic way. They are not discretionary alpha, they retain market beta, and they deliberately deviate from the market portfolio.
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