Canadian Investment Review

The Great Smart Beta Debate

Written by Caroline Cakebread on Tuesday, February 24th, 2015 at 2:42 pm

indecision road signWhat’s a great way to kick off a conference on investment innovation? Why not try a debate. The 2014 Investment Innovation Conference began with two discussions on the merits of smart beta with Professor Burton Malkiel arguing its drawbacks and Goldman Sachs’ Kal Ghayur discussing the way it can help an institutional portfolio. Both fell back on solid data – but both speakers came up with a different take.

First, Malkiel — he provided a compelling discussion of factor tilts primarily used in smart beta strategies and why, in essence, that renders them active strategies with different branding. Calling legendary index investor and smart beta proponent, Robert Arnott, one of the greatest marketers alive, Malkiel noted that smart beta strategies are not your average random walk – in fact, they simply offer active management in disguise and any additional return simply comes from the fact that they entail additional risk taking. Here are his five major conclusions:

So how did Goldman Sachs’ Ghayur respond? He focused on research results drawn from the performance of four major factor tilts that predominate in the smart beta space: momentum, value, quality, and volatility.

Looking at cap-weighted factor indexes Ghayur presented data on each factor and its benefits and drawbacks compared to the broad market. For example, he noted that while momentum and value might bring investors a higher total return, they might also bring market-like total risk and drawdown. Volatility on the other hand offers a market-like total return but lower total risk and lower drawdown.

Ghayur also noted another important characteristic of the group as a whole: there is no instance of all factors underperforming the market at the same time in the data his group looked at. And, based on that, it’s worth considering a “factor diversity index” that provides an equally weighted combination of individual factor indexes.

The bottom line for Goldman Sachs’ Ghayur: diversification is still a free lunch investors can count on when it comes to smart beta exposure. Rather than rely on one approach, investors should look at a combination of all of them. Call it a “smarter” approach to smart beta: diversification.

Who wins the debate? Feel free to weigh in below….

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