That's worrisome. So do we replace an existing suite of strategies and ideas with style boxes? With factor strategies? No, these are individually useful tools, none of which stands on their own as a uniquely perfect way to build our portfolio.
So I think there's going to be a lot of tears in the factor landscape. Not spread across the whole factor landscape, but in those who dive into it carelessly, thinking that this is the holy grail.
InsideETFs: When you come to our Smart Beta conference in June, you'll be talking about relative value and its effects on future returns. What were your findings on that? How will that impact investors' portfolios going forward?
Arnott: The findings last spring were that quality was expensive. Momentum was expensive. Low vol was off-the-charts expensive. That value was cheap, and that small-cap was cheap.
And what happened in the second half of the year? Small-cap outperformed, value outperformed. Low vol fell off a cliff. Momentum and quality struggled. So our batting average was five out of five for the second half of last year. I don't ever expect an idea to have that kind of batting average. So I view that as far more luck than skill.
But coming into this year, momentum has flipped. It's not that the momentum stocks suddenly got cheaper, it's that momentum is no longer a tail wind for the FANGs (Facebook, Apple, Netflix, Google] and the bubble stocks. It's now a tail wind for the value stocks. The value stocks have turned. That's now where the momentum is, and momentum says buy value.
OK, well, that's interesting. Quality after the tough run in the second half of last year is now trading a little cheap. Well, that's nice. Value is still trading a little cheap in the U.S. and very cheap outside the U.S. Well, that's nice. Low volatility is still trading at nosebleed valuations. Early last year, three of the four FANG stocks made their way into some of the low-vol strategies. How can you have a low-vol strategy with Facebook, Amazon and Netflix in it, and think you're reducing your downside risk? It doesn't make sense.
And those are now gone. They're not in the portfolios anymore. Guess what? Their beta just popped back up. What a surprise.
But these strategies are almost all still priced at premium multiples. So that's worrisome. If you're paying premium multiples, do you really expect lower downside risk? So they're no longer trading in the top two or three percentiles of historic valuations, but they're still kind of in the 10th percentile of historical valuation multiples. That's still high.
So I'd still be very wary about overrelying on low-vol strategies. I wouldn't say, don't use them. I would say, be careful. Don't expect them to help you much in the next bear market.