Are 'smart beta' strategies really a new and better breed
than competing investment strategies or just an innovative word
trick for something else?
James Montier, a member of GMO's asset allocation team
"When these strategies are corrected for their exposure to
'value' and 'small,' they exhibit no statistically significant
outperformance compared to the cap weighted benchmark. In other
words, the fact that smart beta has outperformed has nothing to
do with the story told (i.e., better covariance matrix,
exploiting index hugging, or contra trading against the cap
weighted benchmark), it is simply that they embed exposure to
value and small, two traits known to have outperformed over
"Smart beta strategies are at the intersection of active and
passive investing. Their goal is to beat the market using a rules
based, transparent, low-cost approach," says Research Affiliates.
of Bitcoin Mania
" from Ron DeLegge's latest podcast
Smart beta strategies in the investment world generally fall
into two camps: 1) Indexes that use a one-dimensional or simple
formulas, like equal weighting all the stocks within a benchmark
like the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA:RSP)
does. Or, 2) Weighting stocks within a portfolio using a
multiplicity of complex factors like book value and cash flow, as
does the PowerShares FTSE RAFI US 1000 Portfolio (NYSEARCA:PRF).
Smart beta's goal is to outperform traditional market cap
weighted indexes and active managers. In less sophisticated
circles, this is just known as "beating the pants off of
ETFs that weight companies by dividends like the WisdomTree
Large Cap Dividend Fund (NYSEARCA:DLN) or the iShares Select
Dividend Fund (NYSEARCA:DVY) are other offshoots of the smart beta
movement, despite their singular focus on dividends.
Over the past five years, PRF and RSP have handedly outperformed
the S&P 500 (NYSEARCA:SPY) and other cap weighted benchmarks
linked to large company stocks.
But even with impressive historical performance by smart beta
indexes comes a notable admission.
"Seen from another perspective, the smart beta strategies
inherently have value and small size tilts relative to cap-weighted
benchmarks," notes a 2011 paper by Chow, Hsu, Kalesnik and Little.
Isn't that essentially the same point Montier, a critic of smart
beta, makes? Wouldn't this point also make smart beta
strategies essentially an old concept but in entirely new
Furthermore, can't investors simply tilt their portfolios to
overweight small cap and value stocks with corresponding funds,
rather than relying on a smart beta ETF to do it for them?
Another issue deals with whether smart beta strategies, which
have been optimized in a financial laboratory, can replicate that
same type of historical success in the real world. Regardless of
how long a smart beta strategy has been backtested, the real test
is how it performs in the future.
"Smart beta is an impressive branding story. Investors should
question the labels and recognize the emotion that may be involved
in the narratives, said Colin McLean, a writer for the CFA
Sounds like pretty smart advice for even the dumbest
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