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Rob Arnott, argues that the good recent performance of many smart beta strategies has mainly been driven by rising valuations. He also states that only value strategies, such as his own company’s fundamental index approach, currently “show some degree of cheapness, precisely because their recent performance has been weak”.
We agree that valuation is always a factor that should be taken into consideration. When we are studying factor returns we prefer to use extended sample periods of up to 80 years to limit the impact of multiple expansion on factor premiums. But our extended analysis shows that momentum, low volatility and quality are distinct factor premiums that can deliver regardless of valuations.
So we do not agree with the implicit view that smart beta’s good recent returns have been all about valuation. While valuation is currently a particular concern for generic factor strategies, such as low-volatility and profitability, in our strategies we are able to mitigate this risk to a large extent by always taking valuations into account in the stock selection process.