History repeating itself

Category: Asia, Global, U.S.A.

At times, smart beta brings to mind that old saw about hedge funds being a compensation scheme masquerading as an asset class. In this case, we might be looking at a marketing category masquerading as an asset class. Or even a fee structure masquerading as an asset class?

Look at it this way: what kind of beta isn’t smart? Or rather, what investment product provider is ever going to label something dumb beta? It’s unlikely that any investment offering beyond the most basic tracker fund will be packaged as delivering the market and nothing more, and one wouldn’t expect even the simplest tracker products to be served up without at least some differentiating bells and whistles.

And after that, the sky’s the limit in terms of how MENSA-level smart your smart beta is supposed to be. Since there’s no unambiguous definitional demarcation between active and passive investing when you get to complex smart beta products, institutions can amuse themselves trying to unravel exactly what they’re getting, or simply go ahead and buy because it’s called smart beta. But as has been said elsewhere, the idea that choice has dropped out of the equation and that investing in smart beta is a fundamentally passive approach is illusory. Choice of product, choice of index, choice of factor: it’s all very much an active, selective process. The only choice not involved is the choice made by an active investor that commands a fee premium. And you have to wonder how many institutions honestly favour smart beta strategies through a true understanding of how these work, and how well suited they are to current market conditions, and how many simply look at the management fees.

There’s another, not so flippant parallel that the proliferation of smart beta products brings to mind: the Global Financial Crisis. Relentless pressure among vendors to innovate and bring new financial products to market; an institutional investor base sold on one particular version of received investment wisdom and eager to snap up any spicy new variation on the same underlying flavour: what does that remind you of? Remember UBS’ problems with ETFs, the classic vehicle for smart beta offerings, and ever wonder whether we’re looking at another oversold investment product bubble – or worse? Or does that sound like an overblown comparison? One data point AAM tracked down puts US subprime mortgage origination in 2006 at just over US$600 billion. And now we have BlackRock predicting worldwide AUM for smart beta ETFs at over $1 trillion by 2020. Plus ça change.