Kind of an Oxymoron

We all know that passive management is all the rage lately, and now the rage within the rage is my new favorite oxymoron.  It's 'Active-Passive' management, also known as 'Smart Beta'.  Basically it's an ETF that is constructed slightly differently than it would be to target the benchmark index that it is supposed to track.  This is done in order to take advantage of broad trends in the market.

For example, suppose one thinks that over the long-term interest rates will be going down.  This means that utility stocks will probably be strong.  So a 'Smart Beta' S&P 500 ETF constructed to take advantage of this could be made to consist of overweighting the utility sector.  Right now the S&P 500 utility weighting is about 5%, so in this new ETF the weighting could be say 10%. 

At the same time if one thinks that the technology sector will underperform they could make the weighting 20% in this new ETF instead of the 25% that is the current index weighting of the S&P 500 Index.  So now this new ETF is roughly 90% correlated to the S&P 500.  So in essence it's an S&P 500 Index ETF with a 'twist'. 

So 'Active Passive' isn't truly passive because there is an active component and it isn't truly active because once the ETF is constructed and starts trading, it can only be rebalanced at certain preset time periods...for example once a quarter or once a year. 

RSP is the Guggenheim S&P 500 Equal Weight ETF is a Smart Beta ETF that has done very well.  This ETF weights all of the stocks that are in the S&P 500 Index equally, as opposed to the S&P 500 Index which weights the stocks by market capitalization.  For example, in the S&P 500 Index the largest companies like AAPL carry the most weight while in RSP every company has the same weight.  AAPL is the exact same weighting as the smallest company in the Index when the ETF is rebalanced each quarter.

Because of this dynamic RSP has a much greater exposure to small cap stocks than SPY and RSP has greatly outperformed SPY over the long-term, having appreciated +226% since the lows of 2009 while the SPY is up +169% in the same time period.