‘Smart Beta’ 5: No Alpha Here

May 02, 2014

Six Feet Under

Since I already mentioned we’re going to a funeral, you can guess how these tests came out.

Whether you look at one-, three- or five-year performance, these 11 U.S. large-cap smart-beta funds have produced returns in line with their risks. No more, no less. Whether you look for statistically significant alpha or Sharpe ratios, there’s virtually no risk-adjusted outperformance to back up the marketing claims.

I’ll need a few pages to walk you through these tests and their results. I’ll explain to you what these tests do, why they matter and, most importantly, how to understand the results in an uncertain world.

It’s best to compare apples to apples, so I’ll focus most of my tests on a single equity segment, but I’ll branch out to look at all (non-geared) equity funds before we’re done. Ready?

Complex strategies often debut in the crowded U.S. large-cap space; by now, plenty of smarty-pants U.S. large-cap funds have five years of returns history. The U.S. large-cap segment provides plenty of data to test claims that “smart beta” funds generate risk-adjusted excess returns.

We’ll measure the risks these funds have taken and the returns they’ve earned relative to a plain-vanilla benchmark through March 31, 2014. I’ll use the MSCI USA Large Cap Index. (You can read why I chose MSCI here.)

I tested one-year, three-year and, where available, five-year fund total return net asset values against gross total index returns. I’ll walk you through the math you need to understand for the regression results and the Sharpe ratios in the tables below.

The funds appear in order of their total annualized return, from high to low. The MSCI USA Large Cap benchmark data appears in bold.


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