Is Smart Beta Dumb?
Posted: 6 Sep 2015 Last revised: 25 Mar 2017
Date Written: September 5, 2015
The question of beta vs. smart beta has evoked a lot of debate. Investment businesses have thrived on both sides of the question. The smart beta has carved a new business for itself calling the beta dumb, justifying the need for smart beta solutions and advocating a need for moving away from the popular benchmarks that are constructed on market capitalization methodology. The smart beta is built on the premise that popular cap-weighted benchmarks are wrong and inefficient. Even smart beta itself has come under attack. But there has been limited work explaining smart beta and beta together. The debate has added to the list of other debates like; efficient-inefficient markets, random-nonrandom behavior, bell curve or power law etc.. On one side researchers cite proofs that beta is an inefficient measure of risk and on the other side there are proofs that beta is not redundant. The current paper uses the ‘Mean Reversion Framework’ (Pal, 2015) to explain the debate on both sides to explain why beta is neither dead nor dumb and it’s the smart beta thinking that is inaccurate and needs to evolve.
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