How should investors time their investment strategies?
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Being smart about strategic beta
In February, Rob Arnott, founder of Research Affiliates, wrote "How can 'smart beta' go horribly wrong?"
The article has since been widely cited--including by a story memorably headlined, "The godfather of smart beta says that smart beta is stupid"--as well as disputed.
Most notably, AQR chief Cliff Asness penned an aggressive rebuttal. On the topic of to what extent investors should consider current market conditions when investing in "smart beta" funds?
In a nutshell, Asness says only rarely, while Arnott advocates greater activity. (The two agree on this topic far more than they disagree, but the media--and perhaps also the participants--enjoy a scrap.)
This column expands on Arnott's thoughts, as given in a recent telephone conversation.
To back up: the term "smart beta" describes formula-based methods for building portfolios that break the link with market capitalisation, based on strategies like Arnott's Fundamental Index.
For example, his firm's Fundamental indexes select companies that have large economic footprints, such as high revenues, book values, and cash flows, regardless of their stock-market capitalisations.
Funds created to mimic those portfolios are indeed index funds--but they are decidedly not neutral, relative to the stock market.
That might make them "smart" betas. On the other hand, they could be stupid betas, or unlucky betas, or fortunate betas, or accidental betas, or data-mined betas, or even glorious betas.
To complicate matters further, the inventor of the term "stock beta," William Sharpe, says that they are not betas at all. But never mind that.
We don't know what the financial markets will bring. That is why Morningstar renamed smart betas as "strategic betas". We don't know if they are smart, but we do know for certain they are strategies.
Now to the point--strategies move into and out of favour. For example, sometimes value stocks beat growth stocks over a several-year period.
If value is defined by price/book ratios, then value stocks will continue to have lower price/book ratios than growth stocks. (It can be no other way.)