Smart beta has occupied the centre stage in ETF innovation. But smart beta ETFs, the consensus seems, are simply tapping two traditional risk premia: value and small-cap beta. Thus a fundamental, equal weight or low-volatility ETF opts for two premia, but downplays the one that dominates market-cap weighted indexes: momentum.
Smart beta is an alternative to inconstant alpha. An alternative would be an actively managed ETF – often hailed as the next best thing – but regulatory hurdles have so far limited them to a tiny market share because they aren’t fully transparent.
Still, there is a class of ETFs that try to produce alpha – by piggybacking on the F13 filings hedge funds are required to make. Call them alpha replicators.
However, after handily beating the S&P 500 in 2013, they are lagging the index this year, according to a report in ETF.com. However, it’s still early days for these ETFs; they simply don’t have enough of a live history yet.
But there are, intriguingly, some passive products that appear to have added alpha. The most perplexing one, in another ETF.com report, is the 5 basis-point advantage of Vanguard’s Total Stock Index over the MSCI USA Investable Index. As ETF.com reports, since VTI is the market, how can it beat it? The report doesn’t provide an answer, but perhaps it lies in the fact that VTI tracks the CRSP US Total Market Index.
Of the 425 U.S. equity ETFs in the report, 15 showed evidence of alpha. At the top of the list was Guggenheim’s S&P 500 Pure Value ETF, with a 104 basis-point outperformance. But again, the benchmark used is MSCI Large Value Index, not the index the ETF actually follows.
For any advisor, client reporting involves a broadly understood and widely accepted set of indexes. But clearly some indexes are better than others. Whether an index has alpha is another matter.