Special Report: What the Future Holds for Smart Beta. Just How Smart Can Smart Really Get?
New smart beta strategies are emerging but some FAs say returning to basics may be a better step forward. Part 5 of a 5-part Special Report on Smart Beta.
What next for smart beta? Some new smart beta strategies are evolving to deploy the same drivers of returns as hedge funds, Chris Brightman, CIO of smart beta asset management firm Research Affiliates, observes. And some experts say the evolution of smart beta lies in its ability to continuously develop and adapt strategies and factors. But some FAs argue the next evolutionary step for smart beta should be returning to its simple roots.
Classic smart beta strategies include factors such as small companies, value, quality, momentum and low volatility. But new smart beta investments are now developing in terms of new sectors they can target. And Martin Raab, co-author of Wiley’s "Beyond Smart Beta," says one development is the introduction of fixed income and bond-based smart beta products. Whereas smart beta traditionally focused on the equities, these new products let investors apply targets to fixed income and bond portfolios. And new smart beta factors are continually being researched, with innovation ongoing in other investment classes and styles, Raab says. But amid the introduction of new smart beta fund types, some experts say the best development for smart beta would be a return to simpler strategies.
Over the past few years, fund companies have created different recipes for smart beta by including multiple factors and algorithms that decide when to overweight and underweight positions in the portfolio, says Brightman. These recipes are created with the hope they will be better than everyone else’s. But in the process of adding investment complexity, Chris Cordaro, CIO of $3.1 billion AUM RegentAtlantic, says some smart beta funds may have gone too far. The complexity of smart beta is “absurd” now, he says. By continually adding new factors, some smart beta strategies have become opaque and overly sophisticated, causing the pendulum to swing too far in one direction, he says. And swinging too far in one direction has violated Cordaro’s investment principles.
There are five key virtues of a wise investor: curiosity, courage, thrift, patience, and humility, Cordaro says. But by overcomplicating smart beta strategies, Cordaro believes fund managers have broken one of the most important investment principles: humility. Strategies becoming overly complex is a recipe for trouble and many smart beta strategies are getting “a little too big for their britches,” he says. And Brightman agrees: “If an investment is just plain complicated, then it is not smart beta.”
“Peanut butter and jelly is good. You don’t need to add a whole lot more too it. And smart beta is the same way,” Cordaro says.
When smart beta investing becomes overly complex, funds introduce the possibility for error, he says. By being overly smart and using 10 different factors with changing algorithms when constructing a smart beta investment, you destroy what you were trying to build in the first place and end up too far in the active management camp, he says.