A smart beta growth strategy, according to Research Affiliates, combines the low investment factor with high profitability to create sustainably faster EPS growth. Since profitability negatively correlates excess returns with value, a smart beta growth index still provides some diversification to a value portfolio while offering earnings growth.

Over the 40 years from January 1968 to March 2017, a low-investment, high-profitability approach posted positive excess real returns from yield, valuation expansion and earnings growth. The authors attribute the outperformance to two main explanations. One, that these companies don’t invest because they face a high cost of capital, are somewhat riskier, and therefore investors will be compensated by higher returns

A second explanation involves investor behavior, assuming that profitability is persistent, but that many investors are unaware of this, therefore future profitability is not fully reflected in current prices.

“Low investment firms achieve higher growth in EPS by avoiding new projects with low returns on capital,” says Brightman. “Investors seem to find these low investment companies boring; despite healthy returns on capital and superior growth in EPS, investors set low prices for low investment firms. Investors in these low investment companies receive higher earnings and dividend yields, higher growth in EPS, and higher returns.”
 

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