// By Jack C. //
One hundred and three companies support smart-beta investing, according to market giants BlackRock. Smart beta is thought to be, at least by those who believe in it, an answer to inefficiencies in the market due to it’s current state, the S&P500 and DOW Jones and their all-time highs go to show just how unprecedented the situation is. The reason for smart beta comes from the misleading nature of cap-weighted funds (Exchange Traded Funds in which a companies weight is a factor of it’s capitalisation) that entice investors into high capitalised company investing.
Alpha, beta, smart beta
Mr. Sharpe first introduced his Alpha/Beta capital asset pricing model in 1972, this model entails that there are two factors that contribute to the return on a stock: the first is the actual return thanks to the risk of the stock, the second is down to market trend (Beta). Beta is like speculation on the sole basis that it’s not down to anything other than the market. So however contradictory or oxymoron-like the term may sound, smart-beta uses passive investing strategies to try and beat an index thanks to a few stocks from the same ETF index. And now any ETF that doesn’t weight it’s stocks by market capitalisation means it’s potentially smart beta. The main goal is to help every stock in a fund perceive growth seen as the logic behind smart beta and it’s different indexes is to sell high performing stocks and buy low performers. This makes for a high yield strategy that, in the long run, gives the market a second wind.
A trend for smart beta
Institutional investors are hooked, more than half deal in such high yield strategies nowadays with the amount rising 36% since 2016. The FTSE Russell research recorded a 8% growth in 2016, amounting to a huge 60% of European asset managers who allocate a part of their AUM (Assets Under Management) to smart beta.
Nevertheless, investors do not believe that this strategy is necessarily a viable one. Experts have said that smart beta may not be as lucrative as some may think. The process called back tests is one of dire importance when passive investing, this process is based on market tests that are able to foresee the trend depending on what you would like to factor in (your investment for example). Unfortunately asset managers are said to be renowned for back testing in an idealistic market scenario, rather than in the unstable and stressful conditions the stock market lives and trades in.
And so, the attractiveness of the lower fees and higher revenues should not lure us into a false sense of security, it should not make unintelligent investors of us… Benjamin Graham would not approve.
The Financial Times Special Report on Smart Beta, The Financial Times, 28/11/2017