Smart beta is not always “monkey business”, say academics

Monkey computerSmart beta returns could not be created by monkeys randomly selecting stocks, says ERI Scientific Beta, which is part of France’s Edhec-Risk Institute. In a paper called ‘Smart Beta is not Monkey Business’, ERI says smart beta outperformance could not be obtained by random portfolio selection and that the inverse of these strategies produces inferior performance. However, the paper does acknowledge that the ‘monkey’ selection theory may hold for some particular smart beta experiments that some researchers have conducted, but that the theory does not hold in general. The paper shows the monkey theory is most true of fundamental indices, as the method of construction is based on accounting criteria that are not associated with any statistically significant risk premium over the long term. The main point is to avoid over generalising about particular specifications of smart beta testing, ERI says. For factor-tilted strategies tested in research, the results suggest that a careful assessment of investment philosophy and index design is relevant to ensure that such strategies do not behave like “monkey” portfolios. ERI Scientific Beta is a provider of smart beta indices and research. ©2016 funds europe

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