How do smart beta indexes differ from conventional indexes?
Traditional stock indexes, such as the Dow and the S&P 500, rank companies by market capitalization. For instance, Apple is the top holding in the S&P 500, representing 4 percent of the index, because the total value of the tech giant's shares outstanding is larger than any other company in the index.
But Guggenheim S&P 500 Equal Weight ETF, a smart beta fund, has an equal stake in all 500 companies in the index. Over the past three years, the Guggenheim ETF has outperformed the S&P 500 by 1 percentage point per year on average. (The fund does lag the S&P 500 in times when the stocks of the largest companies in the index have performed better than the stocks of the index's smaller companies, however.)
More than 45 percent of the assets in smart beta funds are tied to benchmarks that target stocks with growth or value characteristics, and another 30 percent of these types of funds seek out dividend-paying stocks, according to Morningstar. The remainder of these funds have a variety of strategies, ranging from buying shares based on momentum to investing in low-volatility stocks.
Critics like Vanguard's Bogle have expressed skepticism that smart beta funds can outperform lower-priced index funds over time. "Active managers are just trying to come back and say there is a better way to index, when they know damn well there isn't a better way," Bogle told Institutional Investor magazine.
Supporters say smart beta funds can beat returns of traditional index funds over the long run, even when you account for those higher fees.
But most of these products have been around for less than a decade and differ substantially from each other, making their performance difficult to benchmark as a group.
One of the oldest smart beta funds, PowerShares FTSE RAFI US 1000 Portfolio, which started in December 2005, invests in the stocks of the Russell 1000. But the fund weighs its holdings according to fundamental measures—book value, cash flow, dividends and sales—instead of market capitalization like the Russell 1000.
Since its inception through March 13, 2015, the fund has eked out a better return than the Russell 1000 by an average of 70 basis points, or 0.70 percent, per year. It has an expense ratio of 0.39 percent compared with the 0.15 percent expense ratio of the iShares Russell 1000 ETF.
Read MoreDo you really need $2.5 million for retirement?
Asset managers are bringing similar smart beta tactics to the bond market. Last month, BlackRock launched its first smart beta bond fund, iShares Fixed Income Balanced Risk ETF.
Conventional bond indexes favor large issuers with the most debt. BlackRock's ETF uses an index that ranks bonds on credit risk and interest rate risk evenly, and aims to produce a better risk-adjusted return than the benchmark Barclays Aggregate bond index.
It's important for investors to understand the trade-offs their smart beta strategies have under various markets, said Adam Patti, founder and CEO of IndexIQ, a provider of smart beta ETFs and indexes. "These are asset allocation tools, not hot money products," Patti said.