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Investment Innovations – Smart BETA and Risk Factor Investing

Last update on: Jun 19 2020

James Montier of GMO takes apart the latest investment innovations. He says that the financial industry continues to come up with great ideas that it says will be great for investors, but in practice the innovations don’t stand up to their hype. In this essay he takes a look at smart beta, risk factor investing, and more. Even if you don’t agree with him on some or all of the points, you should read the essay. It’s a good example of how to critically examine and evaluate investment ideas. It shows you how to think about investments.

Of course, investment managers have worked out that turning up at someone’s door and saying, “I’ve got this brilliant idea about how to beat the cap weighted benchmark. I’m going to invest in value stocks and small cap stocks!” would get them laughed out of town. But make no mistake about it: that is exactly what just about every smart beta strategy is doing.
One might argue that having exposure to value and small makes good sense. However, from my perspective this is true if and only if the golden rule of investing holds: “no asset (or strategy) is so good that it can it be purchased irrespective of the price paid.” Even value (cheap price to book) and small cap stocks are not guaranteed to outperform independent of their pricing!
If our forecasts are to be believed, then the current juncture represents a particularly bad point in time to be trying to implement a smart beta strategy as both value and small have very unattractive expected returns in the U.S. on our data.



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