Stellar performance only exists in backtests and has no indicative power for real performance, the authors wrote. We find strong support that data mining in backtests accounts for the performance deterioration.
In other words, ETF sponsors are finding strategies that worked brilliantly according to their historic data — but that arent working now.
Of more than 700 U.S.-listed smart-beta ETFs, about 60% have undershot their indexes since the start of this year, according to data compiled by Bloomberg. The median fund has lost about 1.5% on a total return basis, compared with a more than 10% gain for the Vanguard Total Stock Market ETF.
The booming smart-beta industry accounts for more than a fifth of the $4.8 trillion U.S. ETF market.
Its a blend of active and passive investing that seeks to deploy popular quant strategies in an ETF wrapper. Rather than weight stocks simply by market capitalization like a vanilla index fund, it typically uses factors such as how cheap they are or their growth potential.
The research, titled The Smart Beta Mirage, is the latest in a series of criticisms leveled at industry, but smart beta still has plenty of advocates. The strategies used by the investing style are designed to work over the long term, so periods of underperformance are expected and deviation from the benchmark is practically by design.
Smart beta fans like Rob Arnott of Research Affiliates have repeatedly argued that the basic concept of breaking the link between market capitalization and weighting in a portfolio still holds good — even if the industrys breakneck growth has stretched the definition.
Nonetheless, the new studys findings echo much earlier observations in the ETF sphere.
A white paper from Vanguard Group in 2012 identified a pattern among indexes created for fund launches using backfilled performance data in which most fared well before inception but generated weaker returns once turned into ETFs.
[More: Smart beta continues to confound advisers]
The post Smart-beta funds don’t live up to the backtesting appeared first on InvestmentNews.
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