Here Comes Multi-Factor Smart Beta

John Authers at the Financial Times:

Why multi-factor funds are smarter beta
A fascinating new take on an old strategy tries to beat the market for longer

Smart beta is getting smarter. In the process, while at risk of becoming more esoteric and harder to sell, it may be putting itself on a firmer footing when it comes to claims that it can beat the market in the longer term. 

For the uninitiated, smart beta is the catch-all term for rules-driven quantitative strategies that take major indices and reweight them so as to create a better chance of beating the market in the long term — if all goes well. They cost more than a standard passive (or “beta”) fund, but not much more, and the hope is that they can beat the benchmark by a little more than the difference in fees.

Typical strategies include weighting towards value (cheap) stocks, or stocks with momentum, or stocks with high dividends or low volatility.

The greatest problem with the concept is that if it is successful, it should carry the seeds of its own demise. Once investors have cottoned on that cheap stocks outperform, more will buy them and the anomaly will disappear. The same is true of other anomalies. Put even more simply — eventually you will run out of the greater fools prepared to buy what you are selling and sell what you are buying.

Further, even as these factors should logically lose their power in the longer run, there is also the problem that they tend to be cyclical. The value effect, for example, is strong and has been observed over many decades. But value investors have suffered significant underperformance for the rally of the past five years, just as they did at the top of the bull market in the late 1990s. Similarly momentum usually works beautifully, but occasionally crashes.

The new answer is to create multi-factor funds. Combine several factors in one fund, and you will always have the dominant factor of the moment pulling you through. And you might just have reached the holy grail of the fund that stays ahead of the market all the time....MORE

Why multi-factor funds are smarter beta

Man, I dunno, it seems easier just to buy Congress and have them mandate your product.