A Critic of Smart Beta Investing

Smart beta is a form of stock investing that is sort of passive investing or modified index investing. It first is based on academic research showing that investing based on certain factors increases long-term returns above capitalization-weighted indexes. The definition is fluid, but generally investing in low volatility stocks, undervalued stocks, and other strategies are considered smart beta.

Rob Arnott of Research Affiliates and the PIMCO All Asset All Authority fund is a pioneer of smart beta. His firm developed a series of stock indexes that use fundamentals factors instead of capitalization to weight the stock holdings. But Arnott also is a critic of a lot of smart beta strategies and vehicles. This article presents his views and those of his critics.

“Just like stocks and other asset classes can get cheap or rich, the same thing holds true for these strategies,” Arnott said. “I’d like in five years from now for people to automatically ask if the factor is trading rich.”

It’s an issue that’s dear to Arnott, who spent more than a year telling anyone who’d listen that the only reason most smart beta ETFs succeed is because people rushed into them and inflated their value. His thinking goes that with no structural or economic justification for the factor’s advance, it’s destined to revert to its mean and burn millions of investors in the process.