In the war between conventional share indexes and the smart-beta style that became popular in the last decade, score one for the old school.
With gains in equities confined to the biggest stocks in 2015, equity gauges that emphasize their largest members such as the Standard & Poor’s 500 Index are suddenly trouncing newer rivals that don’t make the distinction. One example is consumer shares, where size-ranked indexes are returning more than twice as much as those that strip out the market-value bias.
It’s a rare soft patch for exchange-traded funds employing smart-beta tactics such as equal weighting, which have seen assets surge 10-fold since 2004 to $406 billion, or about 20 percent of the U.S. ETF industry. Buyers have been attracted to the passive investments that fine-tune indexes by ranking companies by factors other than how big they are.
“People are realizing the smart-beta strategy isn’t a magic wand,” said Rick Ferri, the founder of Portfolio Solutions LLC, a Troy, Michigan–based financial adviser with $1.4 billion in client assets. “We have a large-cap growth market right now, and anything weighted towards smaller stocks is getting beaten up.”
Smart Beta
Stretches like this have been unusual in a six-year bull market where virtually everything has risen, a perfect setup for equal-weighted gauges. While the recent performance is ammunition for smart beta’s critics, it’s hardly a repudiation of the style, according to Eric Balchunas, an analyst with Bloomberg Intelligence.
“Smart beta is here to stay,” Balchunas said. “It’s really an artificial intelligence version of active management, and it costs about half the price.”
Megacap companies like Google Inc., Facebook Inc. and Amazon.com Inc. are up 20 percent or more in 2015, meaning you’ve been better off owning old-style indexes where their influence is greatest. The S&P 500 is size-weighted, so stocks such as Apple Inc. and Exxon Mobil Corp. can be hundreds of times more influential than the smallest companies.
On July 20, the S&P 500 traded at its highest level since June 2013 relative to its equal-weighted counterpart, according to data compiled by Bloomberg. The Value Line Arithmetic index, a gauge containing 1,700 stocks with equal weights, is down 5.6 percent since reaching an all-time high on April 15.
Amazon Influence