grad beta

Smart Beta: Nothing New Under the Sun

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In our daily perusal of investment-related articles, we came across this article1 from the Financial Times claiming that "smart beta is eating active managers’ lunch." As we have previously noted, smart beta is just another term for exposure to the dimensions of expected return (e.g. size, relative price, and profitability) beyond simple equity market exposure. We do not argue with Burton Malkiel when when he says, “Smart beta portfolios are more a testament to smart marketing rather than smart investing.” Our primary issue with the smart beta approach is the idea that it is somehow taking advantage of mispriced securities. We at Index Fund Advisors maintain that an investor’s best possible starting assumption is that all securities are correctly priced to reflect their non-diversifiable risks, and securities with higher expected returns must have higher levels of risk. As the author of the Financial Times article (Sophia Grene) notes, "Smart beta products are mostly based on academic research that has identified a number of risk factors—specific portfolio exposures that have historically delivered excess returns over long periods of time." Clearly, she is referring primarily to the research of Eugene Fama and Ken French that has identified the risk factors that explain more than 90% of the variation in returns of diversified portfolios.

Ido Eisenberg, a portfolio manager at JPMorgan Asset Management notes a problem with the current generation of smart beta products when he says, “Most smart-beta products exploit just one return factor. By contrast, the next generation of strategic beta strategies will be intent on solving more than just single factors. These strategies will seek global equity returns from across multiple distinct return factors while simultaneously reducing volatility with diversification.” Sophia Grene identifies this as “the Holy Grail of investments”.

When we read that paragraph, we could not help but exclaim, "Hello! That is exactly what we at IFA have been advising investors to do since 1999!" As far as we are concerned, there is zero need for investors to wait for the next generation of smart beta products. The current generation of funds from Dimensional Fund Advisors (DFA) delivers these objectives at sensible prices. If you would like to learn more about how IFA can build a smart portfolio for you that considers all the compensated risk and return factors, please give us a call at 888-643-3133.

1Grene, Sophia, "Smart Beta Is Eating Active Managers’ Lunch", Financial Times, 11/16/2014.