With the advent of smart beta it was only a matter of time before the appropriate use of “smart” was analysed and questioned. A paper to be published in the forthcoming summer 2014 issue of The Journal of Portfolio Management looks at the active choices of smart beta strategies and how and when they can be labelled “smart”.
In the abstract the paper’s authors, Bruce Jacobs and Kenneth Levy say:
Smart beta strategies aim to outperform the capitalization-weighted market through relatively simple alternative weighting methods that emphasize a handful of factors such as size, value, momentum, or low volatility.
Because of their simplicity, smart beta strategies bear a resemblance to passive investments. Yet, smart beta strategies are the product of active choices and can be compared with active multi-factor strategies (“smart alpha”).
When considering any active strategy, investors should have a clear understanding of the sources of expected returns, the stability and sustainability of those returns, the risk exposures and risk controls, the liquidity demands of the strategy, and whether the management costs are commensurate with expected results.
Only then can investors determine which strategies are deserving of the “smart” label.