From Advisor Perspectives:
If you rely on “smart beta” strategies to achieve returns that you
hope will beat the broad market, then you also need a response to the
criticisms posed by Bill Sharpe [he of the ratio], the Nobel laureate and Stanford
economist. Sharpe uses unassailable logic, in my opinion, to demonstrate
why smart-beta strategies must eventually do no better than the market.
“When I hear smart beta, it makes me sick,” he said.
Sharpe spoke at the CFA Institute Annual Conference in Seattle on May 5.
He also explained why a static 60/40 asset allocation has important
limits. But let’s look at his criticisms of smart beta first.
Sharpe did not offer a precise definition of which strategies he
would include in the definition of smart beta. But in an email exchange,
he wrote that it would at least include portfolios that overweight
small-capitalization or value stocks, as well as alternative weightings,
including fundamental indexing.
The question Sharpe posed for a smart beta portfolio is whether it
can be good for everyone. If so, then that would imply that he and his
friends are dumb, because they hold the market portfolio. Other
investors who underweight those stocks that are overweighted by the
smart-beta strategies must be “really dumb,” he said.
The market must therefore be divided between smart, dumb and really dumb investors.
“If that’s your story,” Sharpe said, “then smart beta is a way to exploit stupidity.”
“If so, then I would suggest that before too long, the really dumb
ones will at least begin to choose index funds,” he said. “Maybe some of
the Index-fund people will try to move in your direction,” at which
point the advantage of smart-beta funds would be eliminated.
“I think there are all kinds of confusion out there,” Sharpe said in
regard to smart beta. “I don’t think it will work in the future.”
He said he has seen what appeared to be empirical evidence of alpha,
only to see that alpha fail to show up in other countries or disappear
after a few years. He acknowledged that some strategies, like
fundamental indexing, rely on proprietary methods and cannot be
replicated mechanically, and therefore he cannot say for sure whether
they would fail such a test....MORE
