Is Smart-Beta Investing Smart?

Smart-beta investing is getting a lot of attention and Chris Brightman, chief investment officer of Research Affiliates, has covered a lot of ground in this territory. However, while this investment methodology has been gaining popularity, Research Affiliates is warning investors that a crash may be coming. In a recent interview with Barron’s, Brightman shares his thoughts and concerns on the subject.

Unlike traditional market-weighted indices, smart-beta investing uses measures such as volatility, valuation and earnings to create funds. Research Affiliates has applied years of research in this space to create index funds for companies such as Pimco, Invesco PowerShares and Charles Schwab & Co., some of which have demonstrated strong performance.

While Brightman doesn’t say a crash is imminent, he points out that some smart beta fund categories are “attracting quite large inflows of assets” because investors are drawn to the notion of using strong fundamentals that could better withstand the vagaries of the market. He says that if an investor chooses this strategy, they should do so based on long-term goals rather than short-term hopes of outperforming the market. If choosing only one smart-beta style, Brightman advises a “fundamental index based on value” which “tends to favor cheaper companies and systematically rebalances into those cheaper companies.”

The biggest mistake investors make, says Brightman, is “performance chasing.” He refutes conventional wisdom that as people age they should move more of their portfolio into bonds “irrespective of the real yields” but concedes that the “most overvalued stock market in the world is the U.S. equity market.” So, what’s an investor between and rock and a hard place to do? “Fortunately,” says Brightman, “there are cheap assets out there: emerging markets equities are extraordinarily cheap.”