The factor wars have begun.

After Research Affiliates CEO Rob Arnott clarified remarks portending a ‘crash’ in smart-beta investing, many questions surrounding the viability of the concept’s strategies and factors remain.

At Charles Schwab’s Center for Financial Research, alternative beta and asset allocation strategist Tony Davidow agrees with Arnott’s central point — advisors and investors should take care when selecting smart-beta products.

“Not all strategies are created equally,” says Davidow. “Clearly momentum strategies are different from fundamental indexing.”

Davidow is a practitioner of fundamental indexing, a portfolio strategy pioneered by Arnott and Research Affliates where stocks are weighted not by market capitalization, but by fundamental factors such as value, cash-flow and dividends.

“We’re focused on helping people distinguish between the multitude of products and strategies,” Davidow says. “That has to be the starting point.”

In a media call on Thursday, Arnott said that while fundamental indexing is not the only strategy that can result in well-performing smart-beta portfolios, the proliferation of new strategies and factors is leading to a complicated landscape in which some products labeled as 'smart beta' produce the opposite approach.

Arnott argued that academic researchers are using recent past performance as evidence of the viability of a factor or strategy — but that in some cases that past performance is due to the rise in the relative valuation of the strategy, leading practitioners and asset managers to offer products that are buying more expensive stocks rather than harnessing a fundamental driver of alpha.

To untangle valuation from actual outperformance, Arnott proposed dividing alpha into two concepts – structural alpha from the effects of the factor, and situational alpha from the growth in relative valuation of the product.

“It is interesting that Rob says the smart-beta picture is becoming too complex, and he’s now introducing more complexity with a new way to think about alpha,” Davidow says. ”What he’s saying makes sense, some of these strategies are rich in academic history and rigor and that will play out over time, while others are byproducts of short-term phenomena that exist in the marketplace.”

Both Arnott and Davidow believe that value-based strategies are poised to outperform,

“We had picked up on the valuation issue, too,” Davidow says. “Fundamental indexing is poised to do well, we have believed that the market would shift from momentum to fair valuation, and we’ve been seeing that change over time.”

The best bet in the near-term? Emerging-market value, according to Arnott.

“The reality is that current emerging markets are cheap,” Arnott said. “They’re so cheap that value strategies should be growing by 10 to 20 percent per annum over the next five years. That’s why we’ve been pounding the table on fundamental indexing the emerging markets and deep value in emerging markets.”

Davidow says that value’s recent underperformance is coming to an end.

“Last year was rough on the value factor and the fundamental indexing strategy,” Davidow says. “The beauty is that they don’t change what they do, over the long run you’d expect to see the returns from the value premium. There will be periods that they lag, and then you’ll see a dramatic snapback.”

Arnott said that advisors and investors should consider the relative valuation of a factor or strategy before adopting it based on historical performance.

Investors should first consider whether the proposed strategy makes sense, Davidow says.

“I think you have to start with looking at how strategies are poised to perform in a market environment,” he says. “Then we can look at today’s environment and use relative valuation to determine which strategy is likely to do better going forward. It’s a good complementary metric.”

Using Arnott’s measure, factors like low-volatility and quality have enjoyed good performance in recent years due to a rise in relative valuation, not because the factor has a significant impact on returns.

Momentum, while a significant factor according to Arnott, is difficult to use as a predictor of outperformance because of the level of turnover in momentum portfolios

“I’m skeptical of some of these strategies, too,” Davidow says. “Not all of these new strategies are going to deliver the same experience. On the other hand, competition is a good thing if the end result is more options for consumers.”

Yet Arnott’s recent whitepaper, prognosticating a possible ‘crash’ in smart beta as investors piling into factors or strategies expecting outperformance end up underperforming the markets, provoked an outcry from some smart-beta practitioners,

“We published our education over time in a long-term educational format,” Davidow says. “He published a paper and he had a splashy headline. It definitely got attention, but it might have also distracted from the paper’s point.”

Hedge-fund boss Cliff Asness, co-founder of AQR Captial Management, was moved to publish a paper of his own in response to Arnott, arguing that it’s better to diversify across factors that work over the long-term.

Asness said that moving in and out of factors according to valuation amounts to an attempt to time the market.

“Cliff said that the siren of timing is dangerous,” Arnott said. “Chasing whatever factor is cheap is dangerous, too. On the opposite shoals, chasing factors with the best recent performance is even more dangerous than Cliff’s sirens. Cliff says that multiple small factor bets are okay, and I’m advocating big factor bets. Factors with strong past performance shouldn’t be dismissed merely because they’ve risen in relative valuation, but I would be more willing to shun factors that have become very expensive and seem to have performed well by dint of becoming expensive.”

That means that practitioners and academics will have to provide more robust information to advisors and investors on how their strategies function and perform, says Davidow.

“I think it’s incumbent on all of us who are researching smart beta that we do a better job in educating consumers,” Davidow says. “I’m encouraged because it seems like the discussions have evolved from do these strategies work to how or why do they work and how do we distinguish between them.”