The Smart Beta Mirage
44 Pages Posted: 1 Jul 2020 Last revised: 24 Jul 2020
Date Written: June 9, 2020
We document sharp performance deterioration of smart beta indexes after the corresponding smart beta ETFs are listed for investments. Adjusted by aggregate market return, the average return of smart beta indexes drops from 2.77% per year “on paper” before ETF listing to −0.44% per year after ETF listing. This performance deterioration cannot be explained by strategic timing in ETF listing nor explained by time trend in factor premia. We find evidence of data mining in constructing smart beta indexes as the post-ETF-listing performance decline is much sharper for indexes that are more susceptible to data mining in backtests. Our results caution the risk of data mining in the proliferation of ETF offerings as investors respond strongly to the stellar performance in backtests.
Keywords: ETFs, factor investing, smart beta, data mining
JEL Classification: G10, G20
Suggested Citation: Suggested Citation