Smart Beta: The Good, the Bad, and the Muddy

Abstract

The authors describe the background of factor investing in its smart beta form and discuss why factor investing has become a popular investing style. They also discuss a number of reasons for skepticism regarding ex ante expected factor returns.

TOPICS: Portfolio management/multi-asset allocation, factors, risk premia, style investing

Key Findings

• • Factor investing is typically discussed using the language and machinery of efficient-markets models, yet investors are primarily expecting anomalous excess returns.

• • There is reason to be skeptical of claims that factor investing is delivering gross investment returns similar to that of traditional active managers but with lower fees.

• • For factors with risk-based explanations, even in the presence of significant factor premiums, the market portfolio is still likely to be the optimal portfolio for most investors.