Smart Beta ETF Investors Bad At Timing

September 16, 2016

I have to admit I have a bit of a love/hate relationship with smart beta.

On the one hand, I cut my teeth in the early ’90s working for Wells Fargo Nikko Investment Advisors, where some of the most interesting products we had were “Tilts & Timing” strategies that would be firmly in “smart beta” territory today. I also believe it’s a good thing that investors have more tools.

Still, I always worry that with more complex products if investors truly understand what they’re buying, and whether they’ll use all these sharp new tools wisely. So I finally grabbed some data to try and back up my concerns.

The normal way of thinking about this problem is to look at the difference between the time-weighted returns of a fund (the SPDR S&P 500 (SPY) returned 1.35% in 2015) and the dollar-weighted returns of the same fund (the average dollar invested in SPY returned -4.9% in 2015). Doing so, theoretically, lets you account for investors’ tendency to chase returns—buying high and selling low. 

Bad Timing Prevails

This is hardly a new idea. Boston-based Dalbar has been publishing its Quantitative Analysis of Investor Behavior since 1994 using these methods, and it’s shown, month after month, year after year, that investors get the timing wrong far more often than not.

Here’s a tidbit from their latest study:


  Investor Returns  
Asset Allocation Funds Fixed Income Funds Inflation S&P 500 Barclays Aggregate
Bond Index
30 Year 3.66 1.65 0.59 2.60 10.35 6.73
20 Year 4.67 2.11 0.51 2.20 8.19 5.34
10 Year 4.23 1.89 0.39 1.88 7.31 4.51
5 Year 6.92 3.28 0.10 1.58 12.57 3.25
3 Year 8.85 3.81 -1.76 1.07 15.13 1.44
12 Month -2.28 -3.48 -3.11 0.95 1.38 0.55


Looking at the returns of actual investors in equity funds versus the S&P 500, the evidence is pretty damning. Left to their own devices, investors get it wrong. Over the past 30 years, the average annual investor return in equity funds is just 3.66%, compared with 10.35% for the S&P 500.

To be fair, there are criticisms of this methodology; notably, that a small fund with consistent inflows will look like it has “bad” investor returns because of how IRR calculations are done (a point made in an excellent Vanguard paper a few years ago). Still, it’s the best tool we have for analyzing the performance-chasing phenomenon.

With that in mind, I was curious how smart-beta investors have been doing relative to their passive brethren, so I ran a handful of studies looking at different sets of funds.

The results tell a cautionary tale, but one with a sliver of hope at the end.


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