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Word of caution over smart beta trend
(Pictured: Jason Hsu)
The two big trends for fund managers in 2014 were smart beta and outcome-oriented investments. Hardly new concepts, but they struck a nerve with investors still a little shaken from the global financial crisis. Research Affiliates, which came up with the “fundamental index” that started the smart beta trend, has a word of caution for investors.
Smart beta is still in need of greater transparency and lower fees to be truly effective to investors, according to Research Affiliates’ co-founder (with Rob Arnott), Jason Hsu.
In a note to clients last week, Hsu wrote that smart beta strategies had the potential to be “the prime alternative to active management” only when designed properly, just as cap-weighted index funds had done 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 by Vanguard Investments in 1976, he said.
To a large extent, smart beta and outcome-oriented investments are connected. They both focus on after-cost returns. And, in theory, if an investor says what outcome he or she wants, a good quant manager can deliver it through smart beta strategies, with a variable degree of risk.
After all, smart beta is only factor-tilted index funds and outcome-oriented investments are just the old-fashioned balanced funds. I invite readers to dispute this assertion.
– Greg Bright
