Investing Insights Regarding Smart Beta Strategies

At this month’s 2017 Morningstar ETF Conference, Alex Bryan interviewed Chris Brightman, the chief investment officer of Research Affiliates, to discuss concerns regarding smart beta products.

Here are some highlights:

  • Bryan points out that while data provided by Research Affiliates shows strong back-tested performance for some smart-beta strategies, the “live” record of many of these products has been weak. Brightman clarified that his findings are not restricted to smart-beta strategies. “If we look across the full range of ETF strategies that come to market, active and passive, what we find is that the performance leading up to the launch of the ETF is fantastic,” but that post-launch, the performance seems to “flatline.” Brightman has found that when choosing an investment strategy based on past returns, “you’d actually be better off choosing things that had the worst three-year and five-year past returns rather than the best” because, he says, there’s usually a mean reversion at those time intervals.
  • Research Affiliates has found evidence showing that many ETF providers are launching strategies at the wrong time, says Brightman,” but he qualifies his statement by saying “I wouldn’t want to cast blame on the providers because the providers are responding to what the marketplace wants.”
  • Regarding how investors should set their expectations, Brightman says, “What we really want are strategies that are cheap, likely because they have underperformed by a significant amount over a prolonged multiyear period, but have recently turned up. And we want to avoid strategies that have become expensive likely because they have been performing extraordinarily well over a multiyear horizon and, particularly, right after they have turned down.”
  • With respect to asset allocation, Brightman suggests that low-volatility strategies and U.S. stocks are both expensive, adding that “now is a wonderful time to diversify away from the U.S. equity market increasing exposure to EM and the developed ex-U.S.”