The Wisdom of Smart Beta Funds

Bloomberg ran an interesting piece a few days ago focusing on Maneesh Shanbhag who questions the wisdom of many Smart Beta funds, and I think he’s right. Smart Beta funds focus on strategies that have historically beaten the market.

One problem is that these strategies are better at pinpointing losers than at selecting the winners. Also, since the funds focus on particular characteristics like value or momentum, the individual funds can be very volatile.

“What’s promised by some of these ETFs is a certain consistency to their returns,” Shanbhag said. “But if you’re selecting a smaller segment from the universe, you aren’t ginning the benefits from a larger segment that just eliminates the really bad ones.”

For example, according to one study, if you sort stocks by volatility, the most volatile stocks have historically performed the worst. But after that, there’s not much difference. The same effect can be seen with other factors such as momentum, quality, value and size. The best and the middle of the pack are basically the same.

Some researchers believe that factors like low volatility and quality may just be another version of value, albeit one that’s less effective for investors. Others think that gains in some factors may be due to a completely separate and unsustainable phenomena, like low-vol being overweight in defensive sectors that benefited from falling interest rates, Shanbhag said.

“If you take volatility and quality and agree there’s no premium, you’re playing a game with low odds. With that type of diversification, you’ll never be concentrated in the best,” Shanbhag said. “They’re over-promising and under-delivering.”

Posted by on July 11th, 2017 at 12:38 pm


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