How Can 'Smart Beta' Go Horribly Wrong?
21 Pages Posted: 22 Sep 2017
Date Written: February 1, 2016
Factor returns, net of changes in valuation levels, are much lower than recent performance suggests. Value-add can be structural, and thus reliably repeatable, or situational—a product of rising valuations—likely neither sustainable nor repeatable. Many investors are performance chasers who in pushing prices higher create valuation levels that inflate past performance, reduce potential future performance, and amplify the risk of mean reversion to historical valuation norms. We foresee the reasonable probability of a smart beta crash as a consequence of the soaring popularity of factor-tilt strategies.
Keywords: smart beta, factor returns
JEL Classification: G10
Suggested Citation: Suggested Citation