{"id":3224,"date":"2023-10-31T15:01:37","date_gmt":"2023-10-31T15:01:37","guid":{"rendered":"http:\/\/blog.valuengine.com\/?p=3224"},"modified":"2023-10-31T15:26:15","modified_gmt":"2023-10-31T15:26:15","slug":"how-smart-has-smart-beta-been-lately","status":"publish","type":"post","link":"http:\/\/blog.valuengine.com\/index.php\/how-smart-has-smart-beta-been-lately\/","title":{"rendered":"How Smart Has \u201cSmart Beta\u201d Been Lately?"},"content":{"rendered":"<p><span style=\"font-weight: 400;\">Let\u2019s start this topic with describing what Smart Beta is.\u00a0 I\u2019ll be using the definition from Investopedia.\u00a0 \u201cSmart beta investing combines some of the efficiencies and cost savings characteristic of passive investing while mimicking active investing strategies that have the potential to produce excess risk-adjusted returns, also called \u2018alpha.\u2019\u201d\u00a0\u00a0<\/span><\/p>\n<h6 style=\"text-align: center;\"><b>All 5,000 stocks, 16 sector groups, 140 industries, and 500 ETFs have been updated.<\/b><\/h6>\n<h6 style=\"text-align: center;\"><b>Two-week free trial:<\/b><a href=\"http:\/\/www.valuengine.com\/\"><b> www.ValuEngine.com<\/b><\/a><\/h6>\n<p><span style=\"font-weight: 400;\">My thoughts on this in a nutshell:<\/span><\/p>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Smart beta uses alternative index construction rules to traditional market capitalization-based indices.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Smart beta emphasizes capturing systematic investment factors in a rules-based and transparent way.\u00a0 To the extent that these factors can consistently provide alpha, they are capturing systemic inefficiencies in market-weighted pricing.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Smart beta strategies may use alternative weighting schemes such as volatility, liquidity, free-cash-flow, quality, value, small cap, and momentum.\u00a0 All of these strategies have exhibited superior risk-adjusted performance to the S&amp;P 500 during at least one multi-year historical period, thus showing empirical evidence for potential alpha.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">According to ETF Global Insight (\u201cETFGI\u201d) research, smart beta funds now command more than $1.1 trillion in total cumulative assets worldwide.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">Smart Beta ETFs are groups of stock index providers that have been determined as most representative of one or more of the above factors.\u00a0 In addition, recent studies have provided data contending that equally weighting a portfolio is a source of systematic incremental alpha over market-cap weighting.\u00a0 Therefore, in addition to the other eight ETFs representing time-tested smart beta factors, we include equally weighted versions of two benchmark index ETFs.\u00a0 Also, please note that there are multiple ETFs built to capture the same factor.\u00a0 In most cases where several potential choices existed, the ETF with the highest level of assets under management was selected for this discussion. All of the ETFs included in this study have ValuEngine reports available upon demand.<\/span><\/p>\n<h6 style=\"text-align: center;\"><b>Current ValuEngine reports on these stocks or ETFS can be viewed<\/b><a href=\"https:\/\/www.valuengine.com\/rep\/mresearch_report\"><b> HERE<\/b><\/a><\/h6>\n<p><span style=\"font-weight: 400;\">In addition to benchmark ETFs <\/span><b>IVV<\/b><span style=\"font-weight: 400;\"> (iShares S&amp;P 500 Index ETF) and <\/span><b>QQQ<\/b><span style=\"font-weight: 400;\"> (Invesco QQQ Trust representing the Nasdaq-100), 10 ETFs have been included in the study.\u00a0 They include the following list.<\/span><\/p>\n<ol>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>QUAL<\/b><span style=\"font-weight: 400;\"> &#8211; iShares MSCI USA Quality Factor ETF &#8211; tracks an index of US large- and mid-cap stocks, selected and weighted by high ROE, stable earnings growth and low debt\/equity, relative to peers in each sector.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>COWZ<\/b><span style=\"font-weight: 400;\"> &#8211; Pacer U.S. Cash Cows 100 ETF &#8211; screens companies based on projected free cash flows and earnings for the next two fiscal years, then ranks according to their twelve-month free cash flow yield. Free cash flow is the money a company has left after paying operating and capital expenditures.\u00a0 This is generally considered a quality factor.\u00a0 Dividing it by price gives <\/span><b>COWZ <\/b><span style=\"font-weight: 400;\">a value-factor component as well.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>VIG \u2013 <\/b><span style=\"font-weight: 400;\">Vanguard Dividend Appreciation ETF &#8211; presents another way of looking at the quality factor. Although \u201cDividend\u201d is in its name, VIG focuses on dividend growth, not high yield. It specifically selects US-listed firms that have increased their dividend payments for the past 10 years.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>VYM &#8211; <\/b><span style=\"font-weight: 400;\">VYM offers a diversified approach to high dividend yield in a low-cost wrapper. Firms are ranked by forecast dividends over the next 12 months, those in the top half are selected and market-cap weighted.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>SPLV<\/b><span style=\"font-weight: 400;\"> &#8211; Invesco S&amp;P 500 Low Volatility ETF \u2013 SPLV tracks a volatility-weighted index of the 100 least-volatile stocks in the S&amp;P 500.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>MTUM<\/b><span style=\"font-weight: 400;\"> &#8211; iShares MSCI USA Momentum Factor ETF- tracks an index of large- and mid-cap US equities, selected and weighed based on price appreciation over 6- and 12-month periods and low volatility over the past 3 years.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>IWN \u2013<\/b><span style=\"font-weight: 400;\">-iShares Russell 2000 Value ETF- tracks an index of US small-cap value stocks. The index selects value stocks with low price-to-book ratios and similar value metrics from a universe of stocks ranked 1001-3000 by market-cap.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>IWO &#8211; <\/b><span style=\"font-weight: 400;\">iShares Russell 2000 Growth ETF &#8211; tracks an index of US small-cap growth stocks, selected from those ranked 1001-3000 by market-cap based on higher price-to-book ratios and higher forecasted growth.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>RSP \u2013 <\/b><span style=\"font-weight: 400;\">Invesco Equal-Weighted S&amp;P 500 ETF &#8211; simply takes all the stocks in the S&amp;P 500 and weights them equally.\u00a0 We compare this with its cap-weighted alternative, <\/span><b>IVV<\/b><span style=\"font-weight: 400;\">, iShares S&amp;P 500 ETF.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><b>QQQE \u2013 <\/b><span style=\"font-weight: 400;\">Invesco Equal-Weighted Nasdaq 100 ETF &#8211; QQQE equally weights the stocks in the Nasdaq 100. It is compared with <\/span><b>QQQ, <\/b><span style=\"font-weight: 400;\">Invesco QQQ Trust, which cap-weights the top 100 Nasdaq-listed US non-financial sector stocks.<\/span><\/li>\n<\/ol>\n<a href=\"http:\/\/blog.valuengine.com\/wp-content\/uploads\/2023\/10\/231031-ETF-Comparison-for-Herb_Oct222023.pdf\" class=\"pdfemb-viewer\" style=\"\" data-width=\"max\" data-height=\"max\" data-mobile-width=\"500\"  data-scrollbar=\"none\" data-download=\"on\" data-tracking=\"on\" data-newwindow=\"on\" data-pagetextbox=\"off\" data-scrolltotop=\"off\" data-startzoom=\"100\" data-startfpzoom=\"100\" data-toolbar=\"bottom\" data-toolbar-fixed=\"off\">231031 ETF Comparison for Herb_Oct222023<br\/><\/a>\n<p><b>Observations<\/b><b><\/b><\/p>\n<ul>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">For the past 5 years, the dominant index by far year-by-year and on a compound basis has been a benchmark, the Nasdaq-100 as represented by <\/span><b>QQQ <\/b><span style=\"font-weight: 400;\">ETF.\u00a0 That is, the smartest index to have been invested in from our sample was not a Beta at all but a popular market index.\u00a0<\/span><\/li>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">Another way of saying this is that the dominant systematic factors in the market have been <\/span><b>mega-cap size, membership in the technology and\/or communications sectors and listing on the Nasdaq<\/b><span style=\"font-weight: 400;\">.\u00a0 The first factor turns 50 years of factor research and empirical findings on their heads.\u00a0 Sector dominance has generally been shown to be cyclical in generating alpha. Most counterintuitive and devoid of fundamental underpinnings is the concept of being listed on one particular US exchange as a \u201csmart beta\u201d factor.<\/span><\/li>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">Equal weighting has NOT provided better returns for the stocks in the Nasdaq-100 weighting over the slightly modified cap-weighting used for <\/span><b>QQQ<\/b><span style=\"font-weight: 400;\">.\u00a0 As shown in the table above, <\/span><b>QQQ <\/b><span style=\"font-weight: 400;\">has outperformed equally weighted <\/span><b>QQQE <\/b><span style=\"font-weight: 400;\">by nearly 400 basis points (4.00%) annualized over the past five years.\u00a0 The graph below shows the growth of $100 invested in each fund since inception.\u00a0 <\/span>In 11-1\/2 years $100 invested in QQQE grew to $465 while $100 invested in QQQ grew almost 40% more to $642.\u00a0 Referring back to the data table, one can read similar results for the ETFs based upon the S&amp;P 500.\u00a0 Market-cap-weighted <b>IVV<\/b> outperformed equally weighted <b>RSP<\/b> substantially in the 3-month, year-to-date, one-year and 5-year rolling return periods.<\/li>\n<\/ul>\n<a href=\"http:\/\/blog.valuengine.com\/wp-content\/uploads\/2023\/10\/231031-QQQ-vs-QQQE-chart.pdf\" class=\"pdfemb-viewer\" style=\"\" data-width=\"max\" data-height=\"max\" data-mobile-width=\"500\"  data-scrollbar=\"none\" data-download=\"on\" data-tracking=\"on\" data-newwindow=\"on\" data-pagetextbox=\"off\" data-scrolltotop=\"off\" data-startzoom=\"100\" data-startfpzoom=\"100\" data-toolbar=\"bottom\" data-toolbar-fixed=\"off\">231031 QQQ vs QQQE chart<br\/><\/a>\n<ul>\n<li aria-level=\"1\"><b>COWZ, <\/b><span style=\"font-weight: 400;\">which combines a quality factor, free cash flow, with a value component by dividing it by price, has been the top-performing \u201csmart beta\u201d ETF in the study with a 5-year annualized return of 9.43%.\u00a0 This beats <\/span><b>IVV<\/b><span style=\"font-weight: 400;\">, the iShares S&amp;P 500 ETF, by 177 basis points (+1.77%) per year. In fact, it is the only \u201csmart beta\u201d ETF that outperformed <\/span><b>IVV.\u00a0 COWZ<\/b><span style=\"font-weight: 400;\"> also provided a higher dividend yield, 2.1% as compared with 1.6%, and went down only half as much as the S&amp;P 500 during the past 3-month period.\u00a0\u00a0<\/span><\/li>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">The next two smart beta ETFs, the ones that underperformed benchmark ETF <\/span><b>IVV <\/b><span style=\"font-weight: 400;\">by the least, are <\/span><b>QUAL <\/b><span style=\"font-weight: 400;\">and <\/span><b>VIG.\u00a0 <\/b><span style=\"font-weight: 400;\">Both capture the quality factor, albeit in different ways.\u00a0 <\/span><b>QUAL <\/b><span style=\"font-weight: 400;\">outperformed <\/span><b>VIG <\/b><span style=\"font-weight: 400;\">in each period.\u00a0 <\/span><b>VIG <\/b><span style=\"font-weight: 400;\">makes nearly half of the difference back during the past 5 years with a higher dividend yield and a lower expense ratio.<\/span><\/li>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">The other \u201csmart beta\u201d ETFs provide negative alpha, another way of saying underperformance, during the past 5 years.\u00a0 The factors that did not work include low price volatility, high dividend income and price momentum.\u00a0 Again, somewhat counterintuitively, <\/span><b>SPLV<\/b><span style=\"font-weight: 400;\">, representing low price volatility,<\/span> <span style=\"font-weight: 400;\">underperformed <\/span><b>IVV <\/b><span style=\"font-weight: 400;\">during the third quarter, and lost nearly 9% as compared with 7%.\u00a0 Generally, low volatility, correlated strongly with low beta, would be expected to go down less when the market goes down.<\/span><\/li>\n<li aria-level=\"1\"><span style=\"font-weight: 400;\">The Russell 2000 ETFs, representing small cap US stocks between 1001 \u2013 3000 as ranked by float-adjusted market capitalization, greatly underperformed their large cap counterparts in mirror-like fashion.\u00a0 Once again, growth outperformed value as <\/span><b>IWO<\/b><span style=\"font-weight: 400;\">, the small cap growth ETF, outperformed <\/span><b>IWN<\/b><span style=\"font-weight: 400;\">, the small cap value ETF in every period.\u00a0 The axioms often heard quoted in the marketplace, \u201cStudies have shown that over time, value outperforms growth, small cap outperforms large cap and equal weighting outperforms market-cap-weighting\u201d all worked in reverse throughout the past five years.\u00a0\u00a0\u00a0<\/span><\/li>\n<\/ul>\n<h6 style=\"text-align: center;\"><strong>Financial Advisory Services based on ValuEngine research available:\u00a0<\/strong><\/h6>\n<h6 style=\"text-align: center;\"><strong><a href=\"http:\/\/www.valuenginecapital.com\/\">www.ValuEngineCapital.com<\/a><\/strong><\/h6>\n<p><span style=\"font-weight: 400;\">Let\u2019s get back to this article\u2019s opening question, \u201cHow smart have smart beta ETFs been lately?\u201d The answer is that they have performed miserably, consistently underperforming their \u201cna\u00efve beta\u201d counterparts.\u00a0 This is not to say that the long-term research is wrong or presented with distortions.\u00a0 Indeed, this chart shows clearly that starting in 2003 through mid-October of this year, equally weighted <\/span><b>RSP <\/b><span style=\"font-weight: 400;\">has in fact outperformed market-cap-weighted <\/span><b>IVV <\/b><span style=\"font-weight: 400;\">since its inception over a period of about 20 years.\u00a0 But that cumulative outperformance narrowed somewhat during the past 5 years.\u00a0\u00a0<\/span><\/p>\n<a href=\"http:\/\/blog.valuengine.com\/wp-content\/uploads\/2023\/10\/231031-Growth-of-100-since-RSP-incep-Chart.pdf\" class=\"pdfemb-viewer\" style=\"\" data-width=\"max\" data-height=\"max\" data-mobile-width=\"500\"  data-scrollbar=\"none\" data-download=\"on\" data-tracking=\"on\" data-newwindow=\"on\" data-pagetextbox=\"off\" data-scrolltotop=\"off\" data-startzoom=\"100\" data-startfpzoom=\"100\" data-toolbar=\"bottom\" data-toolbar-fixed=\"off\">231031 Growth of 100 since RSP incep Chart<br\/><\/a>\n<p><span style=\"font-weight: 400;\">Similarly, researchers can still find long-term support for very long time frames supporting the value vs. growth thesis and the small cap vs. large cap thesis.\u00a0 Conclusions can differ depending upon the time frame that is presented.\u00a0\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Perhaps the engineers that created these \u201cSmart Beta\u201d indices based upon historical data were not all that smart when it came to constructing factor index ETFs smart enough to outperform in the future.\u00a0 As a 40-year quant, I have concluded that what a quant does best is to <\/span><b>predict the past with ever greater precision<\/b><span style=\"font-weight: 400;\">.\u00a0 As we all know from fund disclaimers, past performance is not a guarantee of future performance.<\/span><\/p>\n<p>_______________________________________________________________<\/p>\n<h5>By Herbert Blank<\/h5>\n<h5>Senior Quantitative Analyst, ValuEngine Inc<\/h5>\n<h5><a href=\"http:\/\/www.valuengine.com\/\">www.ValuEngine.com<\/a><\/h5>\n<h5>support@ValuEngine.com<\/h5>\n<h5>All of the approximately 5,000 stocks, 16 sector groups, 140 industries, and 600 ETFs have been updated on<a href=\"http:\/\/www.valuengine.com\/\">\u00a0www.ValuEngine.com<\/a><\/h5>\n<h5>Financial Advisory Services based on ValuEngine research available through<a href=\"http:\/\/www.valuenginecapital.com\/\">\u00a0ValuEngine Capital Management, LLC<\/a><\/h5>\n<h5>Free Two Week Trial to all 5,000 plus equities covered by ValuEngine<a href=\"http:\/\/www.valuengine.com\/pub\/VeSubscribeInfo?pid=1\">\u00a0HERE<\/a><\/h5>\n<p><strong>Subscribers log in<\/strong><a href=\"http:\/\/www.valuengine.com\/ve\/mainve?pid=1\">\u00a0<strong>HERE<\/strong><\/a><\/p>\n<p>&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Let\u2019s start this topic with describing what Smart Beta is.\u00a0 I\u2019ll be using the definition from Investopedia.\u00a0 \u201cSmart beta investing combines some of the efficiencies and cost savings characteristic of passive investing while mimicking active investing strategies that have the potential to produce excess risk-adjusted returns, also called \u2018alpha.\u2019\u201d\u00a0\u00a0 All 5,000 stocks, 16 sector groups, &#8230; <a title=\"How Smart Has \u201cSmart Beta\u201d Been Lately?\" class=\"read-more\" href=\"http:\/\/blog.valuengine.com\/index.php\/how-smart-has-smart-beta-been-lately\/\" aria-label=\"More on How Smart Has \u201cSmart Beta\u201d Been Lately?\">Read more<\/a><\/p>\n","protected":false},"author":7,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/posts\/3224"}],"collection":[{"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/users\/7"}],"replies":[{"embeddable":true,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/comments?post=3224"}],"version-history":[{"count":6,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/posts\/3224\/revisions"}],"predecessor-version":[{"id":3234,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/posts\/3224\/revisions\/3234"}],"wp:attachment":[{"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/media?parent=3224"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/categories?post=3224"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/blog.valuengine.com\/index.php\/wp-json\/wp\/v2\/tags?post=3224"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}