‘Smart Beta’ 5: No Alpha Here

May 02, 2014

If static hurts your ears, I recommend headphones for this next section. Because when you check the one-year, three-year and five-year alpha significance from our 11 funds, you’ll find a whole lot of noise. And precious little statistically significant alpha. Oh, and of the two alphas that do pass muster, one is strongly negative.

Let me repeat that: These headline smart-beta funds had no statistically significant risk-adjusted outperformance on a one-, three- or five-year basis. They produced no excess returns, except in two instances (out of 28 tests on 11 funds).

One of those two instances was a huge blooper: negative 11.1 percent per year. You’ll find this in the three-year table, along with Wisdom Tree Large Cap Dividend Fund’s (DLN | A-95) 2.8 percent success.

Even at the most generous threshold of 90 percent significance, only four funds generated meaningful alpha. DLN extended its run to the five-year window, and the PowerShares S&P High Quality (SPHQ | A-78) generated 3 percent per year of excess returns over the three-year period. It’s only fair to note that I couldn’t test SPHQ for the five-year period because it changed its underlying index in 2010. The current version of SPHQ is not quite four years old.

Alphawise, DLN is the only smart-beta fund in our sample to produce long-term risk-adjusted outperformance. The other 10 failed to do so.

It Gets Worse

Sharpe ratios, though aligned with alphas, tell an even more drastic story.

Like alphas, Sharpe ratios have a margin of error. To figure out their significance, you have to test whether a fund’s Sharpe ratio is different from the benchmark’s. Again, it’s about error bars.

Not a single U.S. large-cap headline smart-beta fund produced a Sharpe ratio that’s statistically different from the benchmark—not in one year, three years or five years. That’s zero risk-adjusted outperformance for 11 headline smart-beta funds over the past five years, according to Sharpe ratios.

I wondered if things might be different outside of the U.S. large-cap segment, so I did a quick experiment.

Using ETF.com’s Fund Finder and Analytics tool, I searched for equity funds with names that contain words associated with self-proclaimed smart-beta strategies: alpha, achievers, beta, dividend, dynamic, earnings, equal, factor, fundamental (or RAFI), income, momentum, quality, revenue, volatility and yield.

I checked how many had statistically significant alpha against a segment-appropriate benchmark, at the 95 percent confidence level.

The answer: fewer than would be expected by chance. Have a look:

 

Find your next ETF

Reset All