Originally published June 7, 2016
Nir Kaissar at Bloomberg recently published a nice summary of the historical returns of a number of Smart Beta factors, including Value, Size, Quality, Momentum and Low Volatility:
In the brave new world of next generation, active investment management, smart beta is all the rage. Smart beta relies on five major strategies - or "factors" - to fine tune market returns:
Value - buying cheap companies
Size - buying small companies
Quality - buying highly profitable and stable companies
Momentum - buying the trend
Low Volatility - buying defensive companies
Investments built around each of those factors have historically beaten the market, as the following chart shows:
A couple of observations:
- The market is efficient? Really? I don't think so. Excess returns are available if investors focus on the right factors.
- These factors move in and out of favor so nobody should expect each factor to outperform all the time. In fact, Kaissar highlighted the benefits of mixing these factors in order to smooth out the ride.
- It's hard to miss the fact that Momentum had the highest returns of any of the factors listed in this study. Yes, Momentum had the highest volatility, but it also had the highest Sharpe ratio.
Smart Beta is far more than just a catchy marketing phrase. It is a much more effective way to seek excess returns than traditional active management.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.