What’s in a name? Richard Butcher, managing director at PTL, asks how smart is ‘smart beta’ really?

Smart beta is a smart name. The “smart” sounds new, zesty and intelligent and the “beta”, well that’s Latin isn’t it? Sophisticated and clever. Let’s ignore the fact that many trustees don’t know what beta means, in the context of investment, and that most of the rest have to think at least three times before they can decode it.

But is it a smart concept?

Smart-Beta-index

Beta is the return achieved on a given index. A beta fund is, therefore, a passive fund that tracks an index. One of the arguments against passive funds however, is that you get the crud along with the cool.

Smart beta seeks to address this concern and filter out the crud.

Of course, the problem with filtering is that one man’s crud is another man’s cool, so what is considered crud is necessarily a matter of judgement – and the exercise of judgement is, by definition, an active activity.

In other words, a smart beta fund isn’t a beta fund at all its an alpha fund (alpha being the return achieved by the exercise of judgement) and a slightly soporific version of an alpha fund at that – given that it can exclude from its universe of available stocks but not include from beyond it.

So, smart name but misleading and perhaps, even cynically designed to exploit the ignorance of the consumer?

Two other thoughts.

Judgement is rarely always right. This means a smart beta fund may underperform the index that it supposedly tracks in a smart way.

Judgement also costs money, meaning a smart beta fund will cost more than a passive fund (albeit, due to its soporific nature not as much as an unconstrained active fund).

Smart beta is the current flavour of the month and it may well be a good tool, but for the reasons given here, we should be cognisant of the fact that it is not the wonder kid that we are being told it is. It is not the investment tool that will solve all ills.

Smart beta does still have a place in investment. It is a tool with a particular set of characteristics. If those characteristics are the characteristics you need, then smart beta is the tool for you. However it is important to remember that it’s no more valid nor valuable than any other investment tool.

Richard Butcher, independent trustee and managing director of PTL