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Smart Beta Crash Ahead?

Could smart beta’s popularity prove to be its undoing?

According to a report by Research Affiliates, led by CEO Rob Arnott, there is a “reasonable probability of a smart beta crash” — an outcome the report says is a consequence of what it termed “the soaring popularity of factor-tilt strategies.”

That’s tough news for advisors using smart beta strategies — FTSE Russell estimates that 68% of FAs use smart beta ETFs, attracted by their performance.

Explaining the trends that are contributing to that possibility, Research Affiliates (which itself employs smart beta strategies) notes that:


  • Factor returns, net of changes in valuation levels, are much lower than recent performance suggests.

  • Value-add can be either structural, and thus reliably repeatable, or situational (a product of rising valuations), which is likely neither sustainable nor repeatable.

  • 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.


Arnott questions whether the returns from smart beta are sustainable, noting that, “Many of the most popular new factors and strategies have succeeded solely because they have become more and more expensive. Is the financial engineering community at risk of encouraging performance chasing, under the rubric of smart beta? If so, then smart beta is, well, not very smart.”

Arnott notes that, “If the strong performance comes from structural alpha, terrific! If the performance is due to the strategy becoming more and more expensive relative to the market, watch out!”

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