Disclaimer

Please read this important information before proceeding further. It contains legal and regulatory notices relevant to the information contained on this website.

The information contained in the Website is NOT FOR RETAIL CLIENTS - The information contained in the Website is solely intended for professional investors, defined as investors which (1) qualify as professional clients within the meaning of the Markets in Financial Instruments Directive (MiFID), (2) have requested to be treated as professional clients within the meaning of the MiFID or (3) are authorized to receive such information under any other applicable laws. The value of the investments may fluctuate. Past performance is no guarantee of future results. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency.

In the UK, Robeco Institutional Asset Management B.V. (“ROBECO”) only markets its funds to institutional clients and professional investors. Private investors seeking information about ROBECO should visit our corporate website www.robeco.com or contact their financial adviser. ROBECO will not be liable for any damages or losses suffered by private investors accessing these areas.

In the UK, ROBECO Funds has marketing approval for the funds listed on this website, all of which are UCITS funds. ROBECO is authorized by the AFM and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.

Many of the protections provided by the United Kingdom regulatory framework may not apply to investments in ROBECO Funds, including access to the Financial Services Compensation Scheme and the Financial Ombudsman Service. No representation, warranty or undertaking is given as to the accuracy or completeness of the information on this website.

If you are not an institutional client or professional investor you should therefore not proceed. By proceeding please note that we will be treating you as a professional client for regulatory purposes and you agree to be bound by our terms and conditions.

If you do not accept these terms and conditions, as well as the terms of use of the website, please do not continue to use or access any pages on this website.

I Disagree
How Smart is 'Smart Beta' Investing?

How Smart is 'Smart Beta' Investing?

05-06-2014 | Research

Investors increasingly embrace “smart beta” investing, by which we mean passively following an index in which stock weights are not proportional to their market capitalizations, but based on some alternative weighting scheme. Examples include fundamentally-weighted indices and minimum-volatility indices. In this whitepaper we first take a critical look at the pros and cons of smart beta investing in general. After this we successively discuss the most popular types of smart indices that have been introduced in recent years.

  • David Blitz
    David
    Blitz
    PhD, Executive Director, Head of Quant Selection Research
  • Recently introduced smart beta indices claim that it is possible to improve upon a traditional capitalization-weighted index by using some alternative weighting formula 
  • The source of the added value of smart beta indices are systematic tilts towards classic factor premiums which are induced by these weighting schemes 
  • Investors should be aware of the pitfalls associated with smart beta indices, which arise because smart indices are not specifically designed for harvesting factor premiums in the most efficient manner, but primarily for simplicity and appeal 
  • Although passive management can be used to replicate smart indices, investors should realize that, without exception, smart indices themselves represent active strategies

Smart beta, essentially an active strategy

We are often asked whether smart beta investing is a form of passive investing. It is important to realize that it is not. Although passive management can be used to replicate smart indices, smart indices themselves are essentially active strategies. The only truly passive investment strategy is the capitalization-weighted broad market portfolio, which represents the only buy-and-hold portfolio that could, in principle, be held in equilibrium by every investor. 

Smart beta indices are fundamentally different, because they require various subjective assumptions and choices. Their active nature is also illustrated by the fact that they require periodic rebalancing to maintain their profile.

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates
Subscribe

Smart beta in relation to factor premiums

We think it is important to understand where the added value of smart beta as alternative weighting schemes really comes from. Research has shown that the weighting schemes tend to result in structural tilts towards stocks which score high (or low) on certain factors, and that the premiums which are known to be associated with these factors are driving performance. (Research has shown that the weighting schemes tend to result in structural tilts towards stocks which score high (or low) on certain factors, and that the premiums which are known to be associated with these factors are driving performance. (See for example, Chow, Hsu, Kalesnik & Little 2011, “A Survey of Alternative Equity Index Strategies”, Financial Analysts’ Journal, Vol. 67, No.5, pp 37-57). 

For example, compared to the capitalization-weighted index, fundamental indices systematically tilt towards value stocks. These exposures enable the strategy to benefit from the well-known value premium, which, in fact, turns out to fully explain its performance.

But is smart beta investing really smart?

Our view on smart beta investing can be summarized as follows: although smart beta investing may be a good start, we believe that investors can do better. The reason is that the main appeal of smart beta indices, namely their simplicity, is at the same time their biggest weakness. Specifically, we find that the simple tilts towards factor premiums provided by smart beta indices often involve significant risks that are undesirable. 

'Although smart beta investing may be a good start, we believe that investors can do better' 

In this whitepaper we elaborate on these points by discussing the pros and cons of the most popular types of smart beta indices that have been introduced in recent years.

Leave your details and download the report.

This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US citizens and residents.

Subjects related to this article are: