The Paradox of “Smart Beta”
The portfolio management team of the AdvisorShares Peritus High Yield ETF (HYLD) weigh-in on defining managers who are truly active.
The article “Indexing Fans Ask: Who Are You Calling Dumb?” (click here to view) that came out earlier last week was an interesting read. The “smart beta” fund sounds like an enticing concept at face value, but digging deeper, it doesn’t make a ton of sense. The whole point of an index-based fund is that you are tracking an index, generating the beta from broad exposure to the market class, with no focus or expectation of outperforming the index. But saying that these new strategies aim to outperform the index but also keeping generally in line with the index constituents seems to be a paradox.
Beta is beta; you can call it smart, intelligent, or strategic but in actuality these funds are still broadly exposed to an asset class, be it market capitalization weighted or equal weighted, or something in between. Trying to determine allocations based on factors such as volatility, earnings multiples, or momentum seems like a half-hearted attempt at active management.
Be it those that claim to be active managers but are really closet indexers, or these sorts of funds claiming to be some sort of passive hybrid, active management can’t be a partial effort. Alpha comes from skilled active managers that intentionally pick and choose each and every security to create a focused portfolio, and intentionally exclude securities. Holding hundreds of holdings, no matter how you weight them, is not an active strategy. We believe that any ability to consistently outperform an index, and better yet do so while lowering the risk of the fund, can only be done via a truly active strategy.