AQR managing and founding principal Cliff Asness has been an outspoken opponent of smart beta for years. He doesn’t take issue the actual investment strategy, which is similar to the value oriented strategies he himself puts to use, but with the terminology, having listed it as one of his top ten pet peeves earlier this year.
“Even if it’s not the term we’d have chosen, it is being so widely used, we concede. Language is, after all, a democratic process,” he and John Liew write in a new article. But he still wants to make sure everyone is clear that smart beta isn’t new and isn’t beta, though it can be a smart way to invest.
Smart beta is really just a style tilt
Asness’s original objection to the way smart beta was packaged and sold to investors is that it was an active investment strategy in passive, index clothing. A smart beta index weighted by sales instead of market cap, for example, is really just a price-to-sales tilt away from the normal market cap index. It doesn’t matter whether prices were specifically referenced or not, the relationship between the two indices remain. There’s nothing wrong with including that particular value tilt in your portfolio, but Asness has objected in the past that smart beta rhetoric masks what’s really going on.
Price-to-sales is just one example, and Asness calls out value, momentum, and profitability as three of the main tilts that you would want to consider when choosing a smart beta fund. Implementation will differ from one manager to the next, but each style has enough research behind it that the general approach is sound. If you want to go for something more exotic, Asness warns investors to “avoid the perils of data-mined factors or strategies that were chosen to fit history,” and look for strategies that have been proven to work in different times, regions, and universes of stocks.
Taking the beta out of smart beta
Now that Asness has embraced smart beta as a term, he’s going to get the most for his conversion. Instead of settling for single-factor, long-only smart beta products, he argues that investors should also consider multi-factor smart beta for lower transaction costs (by netting out different signals before trading), tax efficiency, and the ability to better manage ‘active risk’.
You could even go long/short on those style factors or include bonds, currencies and other assets besides stocks. We’re starting to move away from the index-style smart beta you usually hear about and closer to quant strategies that AQR specializes in, but that’s the point he’s been making all along.
“If you’re laughing a bit as we extend the ‘Smart Beta’ concept by removing the actual ‘Beta’ part, you are paying attention!” he writes.