How Can "Smart Beta" Go Horribly Wrong?

How Can “Smart Beta” Go Horribly Wrong?

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This is the first of a series on the future of smart beta. 

Key Points

1. Factor returns, net of changes in valuation levels, are much lower than recent performance suggests.
2. Value-add can be structural, and thus reliably repeatable, or situational—a product of rising valuations—likely neither sustainable nor repeatable.
3. 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.
4. We foresee the reasonable probability of a smart beta crash as a consequence of the soaring popularity of factor-tilt strategies.

Because active equity management has largely failed to deliver on investors’ expectations,¹ investors have acquired a notable appetite for any ideas...