Why Factor Tilts are Not Smart 'Smart Beta'

18 Pages Posted: 22 Sep 2017

See all articles by Robert D. Arnott

Robert D. Arnott

Research Affiliates, LLC

Mark Clements

Research Affiliates, LLC

Vitali Kalesnik

Research Affiliates LLC

Date Written: May 2017

Abstract

We challenge the common view that smart beta strategies and factor tilts are equivalent. Initially, the term “smart beta” referred to strategies that broke the link between the price of a stock and its weight in the portfolio or index. Capitalization weighting does not do that — neither does a portfolio that applies factor tilts to a cap-weighted starting portfolio.

Some have suggested that certain smart beta strategies are essentially factor tilt strategies in disguise, which can be replicated with factor tilts applied to a cap-weighted market portfolio. We test this assertion by replicating three first-generation smart beta strategies — Fundamental Index™, equal weight, and minimum variance — with factor tilts. Creating factor-replicated portfolios that match the factor loadings of these smart beta strategies is easy, but the factor-replicated portfolios are poor substitutes for their smart beta counterparts: performance is poor, turnover is high, and capacity is terrible. Why? The simple answer is that construction details matter in achieving both lower trading costs and higher performance.

Keywords: smart beta, factor tilts

JEL Classification: G10

Suggested Citation

Arnott, Robert D. and Clements, Mark and Kalesnik, Vitali, Why Factor Tilts are Not Smart 'Smart Beta' (May 2017). Available at SSRN: https://ssrn.com/abstract=3040970 or http://dx.doi.org/10.2139/ssrn.3040970

Robert D. Arnott

Research Affiliates, LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8700 (Phone)
949-325-8901 (Fax)

HOME PAGE: http://www.researchaffiliates.com/Our%20Firm/Our%20Team/Pages/Rob-Arnott.aspx

Mark Clements

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

Vitali Kalesnik (Contact Author)

Research Affiliates LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8717 (Phone)
949-325-8917 (Fax)

HOME PAGE: http://researchaffiliates.com/index.htm

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