Ferri Vs. Arnott: Is Smart Beta Real?

September 05, 2013

Semantic Smackdown

But it’s that broadening of the definition that Ferri is griping about.

Since the Securities and Exchange Commission allowed PowerShares in 2003 to label its strategies—“which is basically highly quantitative active management put into their Intellidex indexes”—as indexing, the waters have been murkier for investors, Ferri said.

“I’m a purist, and to me, indexing means the cap-weighted version of the market,” Ferri said. “That began in the 1970s with John Bogle, and it has been like that for 30 years until it all changed in 2003,” he said.

“What the general investor out there considers indexing isn’t fundamentally weighting securities, or quantitatively selecting stocks,” he added. ”That’s not what the public believes indexing is.”

In fact, it’s not even the definition of indexing the Securities and Exchange Commission itself adopts on its website. In there the SEC defines an index fund as a fund that tracks a cap-weighted index such as the S&P 500 or Russell 3000, Ferri noted.

“We get calls about it all the time from investors wondering whether this is really better indexing,” Ferri said. “It’s not better it’s just taking more risk in your portfolio to get a higher return.”

That risk might not be market risk—beta—but they are often other risks such as tilting a portfolio toward smaller cap stocks, or focusing on value names.

“I don’t have any problems with the way these portfolios are constructed,” Ferri said. “I have a problem with the marketing. These providers are confusing investors.”

“I totally expect to lose this war, and I told Rob as much, but that doesn’t mean I’m not going to fight the fight,” Ferri said.

 

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