Why your smart beta portfolio might not work

Abstract

Smart beta, which accounts for rule-based factor-tilting strategies that fall between active and passive investment, has emerged as an alternative to active investment after its major decline since the global financial crisis. In spite of the smart beta's remarkable commercial prosperity, many experts in both industry and academia share some concerns. Some of them believe that the marketing hype might confuse investors while others are concerned about the exposure to unintended risks that smart beta products might bring. In this study, we provide a comprehensive review of diverse perspectives from both practitioners and researchers on smart beta and we perform empirical and theoretical investigations on the efficiency of smart beta (or factor-tilting) strategies as investment building blocks. We find that factor-based investment building blocks may cause inefficiency under the mean-variance framework.