What Does It Take for Smart Beta to Be Successful?

There is much room for improvement in smart beta strategies, according to Research Affiliates.

Smart beta is still in need of greater transparency and lower fees to be truly effective to investors, according to Research Affiliates.

In a note, the firm’s Co-Founder Jason Hsu wrote smart beta strategies has the potential to be “the prime alternative to active management” only when designed properly, just as cap-weighted index funds had in the 1970s.

“I hope smart beta funds pull assets away from closet indexers and the high-load, high-fee active products which survive, through effective advertising, at the expense of the investors,” he said.

To create smart beta strategies that benefit the investor, Hsu argued for “systematic and rules-based portfolio construction” that target specific investors’ needs for improved transparency and lower costs.

And these needs have remained the same since the creation of the first index mutual fund, Hsu said. 

The promise made to investors of a “transparent, low-cost, low-governance, high-capacity strategy for accessing the equity risk premium through cap-weighted exposure to market beta” is still relevant, according to the author, but now exists in a multi-factor and multi-beta structure.

However, achieving these goals for the investors through smart beta is still in need of work, Hsu said. The most apparent underlying problem exists in the lack of agreement among managers and investors alike on its terminology and definition.

“Some of our fellow investment managers secretly, and some publicly, hate the smart beta moniker,” Hsu said. “It’s not the ‘smart’ that annoys them. We all think we are plenty smarter than the market.”

The key, instead, is to focus on developing a strategy that is simple, truly diversified, and puts investors’ needs first.

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