Smart beta is a relatively new term, but its roots stretch back several decades. Let's look at the history of how the idea developed.
We'll start with a simple question that has long been asked by students of the financial markets: what explains the difference in returns among stocks?
Back in the 1960s, economists and finance professors developed the capital asset pricing model (CAPM), which suggested that returns were directly related to risk. The formula began with a risk-free rate of return - for example, Treasury bills-plus an additional return for the stock market as a whole, called the equity risk premium. Then the model considered whether a given stock was more or less volatile than the overall market using a measure called beta. If a stock had a low beta - making it relatively less risky than the market - it should have a lower expected return. Stocks with…