The “smart beta” investing movement has gained a lot of followers – and fund inflows – over the past few years. But now there are signs that the influx of money into these approaches may be leading to big trouble, Validea CEO John P. Reese writes in his latest column for Canada’s Globe and Mail.
While traditional index investing involves weighting holdings by their market capitalizations, smart beta approaches often use quality metrics such as profits, debt levels, and share volatility to weight stocks within the index. Reese notes that Rob Arnott – a pioneer of the smart-beta movement — says that rapidly rising popularity of smart beta strategies has created problems. “In recent commentary on his company’s website, he wrote that as more and more investors have jumped on the smart-beta bandwagon, many smart-beta indexes have become substantially overpriced,” Reese writes. “And there comes a price at which even the highest quality company (or index) is a bad investment.” Arnott thinks it is “reasonably likely a smart-beta crash will be a consequence of the soaring popularity” of smart-beta approaches, Reese says.
But both Arnott and Reese say they are finding attractive opportunities in good old-fashioned value stocks right now. “To me, the bottom line is that good investment strategies don’t focus solely on quality or solely on value,” Reese says. “They focus on both. That’s what history’s best investors – people like Warren Buffett, Benjamin Graham and Peter Lynch – have done.
Reese uses his Guru Strategies, which are based on the approaches of some of these great investors and use a blend of quality and value metrics, to highlight three attractive North American stocks. Among them: Westlake Chemical Corp., which gets high marks from his Benjamin Graham-inspired strategy.