Smart Beta, in its broad definition of an asset class alternative to market cap weighting schemes simply does not exist!
Aggregating ETFs designated as ‘smart beta’ in a composite portfolio demonstrates that the term does not lead to the definition of an asset class with specific risk/return attributes. With a one year performance of 18,8% (compared to 20,1% for the broader large cap segment) and a volatility of 8,97% (compared to 9,89% for large cap stocks), the newly invented asset class does not really differentiate from traditional index weighting schemes in its risk/return profile (1).
Still, smart beta large cap strategies have gathered over $25bn in the last twelve months in Europe and North America, that’s a hefty 15% of large cap net inflows, and the theme remains central to investor’s quest for innovative investment solutions.
The reality is that ‘smart beta’ encompasses a wide range of rule-based weighting schemes that match different investment cases: single factor exposures, multi-factor aggregates, rule-based allocations …. You name them.
More importantly, those specific strategies do exhibit significant differences in their risk & return trade-offs, in their sensitivity to market regimes as well as in their diversification properties.
So rather than jump on the latest ‘smart beta idea’, it is therefore of utmost importance for investors to perform a meticulous due diligence on both the index construction methodology (risk/return profile, stability of geographic, sector and factor exposure, diversification properties … ) but also on the capacity of ETFs to replicate the strategy, as unconventional weighting schemes can possibly be more challenging to render investible.
Focus should be on data & facts rather than anecdotal evidence. More on www.TrackInsight.com
(1) Based on a review of a one year (Nov 2016-Oct 2017) performance of 1,449 large cap and 229 ‘smart beta’ ETFs holding respectively $1,7trn ad $210bn AUMs.