Friday, 28 April 2017

Smarter-Beta Faster. Stronger?

Equal-weighted index fund outperformance may be exaggerated.


Smart-beta is another term for rules-based portfolio construction. When it comes to picking stocks, you can look at a company's position in an index (plain, boring index funds), or unquantifiable aspects of like personnel or projects (active/high-conviction investing). Smart-beta differs in that it considers almost exclusively quantified performance measures like momentum, size, or earnings. You would be following a different 'index' than mere size, at presumably lower cost than active management.

Of the theoretically tested 'smart beta' measures, equal-weighted index funds have been suggested to me from three directions as having consistently outperformed the greater market.These funds have the same constituents as their traditional, cap-weighted counterparts, but regularly re-balance from oversize holdings into undersize ones until their weightings are, well, equal. They are meant to avoid bias towards extremely large constituents.

Many argue that smart-beta, including equal-weighting, is a gimmick. That you're not going to get a better return for your risk, but you're going to pay more to try.

However, we cannot ignore that an equal weighted fund like Guggenheim's RSP has, over the last decade, returned head and shoulders above SPDR's S&P500 tracker SPY, even though they hold the same stocks, albeit in different proportions.


Apr '05 - '17Annualised ReturnTotal Return
SPY6.1%8.4%
RSP7.7%9.5%
VTI6.6%8.9%

That said, when dividends are re-invested the gap is much reduced. Is it then worth pouring money into a relatively newer, more expensive, more volatile product? That's really up to you.

This highlights how 'personal' investing is in that because of my age or other circumstances, I may find more utility in the higher dividends of the SPY than the growth of the RSP.

Quite apart from the lower volume and higher volatility, another argument against equal-weighted funds is that you could similarly decrease your exposure to index goliaths through lower-cost, broader index funds like the Vanguard Total Stock Market (VTI).

Ultimately, the heated argument surrounding smart-beta may be too absolutist for reality. Commodification of financial product means that your average punter need not be all-or-nothing in a particular investing style. You really can have a beta each way.

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