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December 06, 2016

Building Confidence in Smart Beta Equity Strategies

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While smart beta strategies have experienced strong flows, assets in these strategies are still small relative to the assets in traditional active and pure passive products.1 We believe current allocations to smart beta portfolios are modest due to three primary concerns around these new strategies, which are explored in this paper.

  • First, some investors have concerns about the robustness of smart beta strategies. While skeptics may question how reliable this research is and how much confidence investors should place in the return potential of common equity factors, the academic research of these strategies has shown strong performance historically.
  • Second, some investors are worried that smart beta strategies have become crowded. Given the popularity of smart beta products, these investors are asking if equity factor portfolios have become overvalued.
  • Finally, some investors are not entirely sure how to evaluate smart beta strategies. There are many different approaches to choose from, and different ways to implement them. What conceptual framework should investors use to evaluate the many alternatives to traditional active or passive options?

Concerns about robustness, crowding and the evaluation framework can explain why some investors have not yet embraced smart beta strategies, but perhaps the biggest reason why smart beta allocations are still modest is because smart beta strategies remain relatively new. Many investors prefer to see a live track record before making a significant allocation. Even when investors are comfortable basing a decision on the economic intuition and academic support for an idea, it still takes time to thoroughly evaluate a new strategy and fit it into an overall equity allocation. The widespread interest in smart beta—by investors, consultants, asset managers, index providers and the financial press—suggests that a thorough evaluation process is currently underway. Contrary to what some skeptics claim, we do not think smart beta is a fad. Rather, we believe the growth of factor-based investing via smart beta strategies is here to stay and will keep expanding in popularity.


About the Author

Andrew W. Alford

Andrew W. Alford

Managing Director, Quantitative Investment Strategies, Goldman Sachs Asset Management

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