WealthManagement.com posted an article titled Rob Arnott Says You’ll Be Sorry For Ignoring Smart Beta Warnings. Arnott notes that part of the outperformance broadly speaking has come from money flowing into these funds creating something of a self-fulfilling cycle. As a reminder, Arnott was very early to smart beta (or any of the other terms you like better), launching a four factor ETF in 2005.
In the article, there are several references to smart beta strategies “trading rich” which is obviously a valuation issue. He says price matters which is hard to disagree with. He gave one example about performance chasing where factors like low-volatility can become dangerously expensive. Indeed, they’re already down 12 percent since August, according to a Dow Jones U.S. market-neutral basket.
I am not sure what that means. The article is current so looking at six months of data, the S&P 500 is up a little over 7% and the two largest low volatility ETFs tracking large cap domestic equities (naming names is tricky for compliance reasons) were up a little over 1%. Clearly a lag but six months isn’t a long period of time. For five years, there’s a different story, the S&P 500 is up 72% and the two ETFs were up 64% and 70% respectively.
Arnott goes on to say he sees this performance chasing as a looming catastrophe for buyers. This seems very unlikely. The downside here is that a given strategy will lag the broad market for an extended period. Taking a very simplistic example between a large cap value strategy and the index, one must outperform and one must lag. There isn’t a scenario where, sticking with the word catastrophe, a value oriented smart beta goes down 40% while the S&P 500 goes up 10%. It would be easy to see that value oriented smart beta up 5% or flat in an up 10% world which isn’t catastrophic unless you have an inordinately low tolerance.
We have said before that if you’re going to pick one of these you have to stick with it as value, sticking with the same example, will most certainly rotate back into favor and outperform for some period and then the pendulum would swing back to growth and so on.
