Probably more than 70 percent of active money managers’ returns can be attributed to the portfolio manager’s use of factor tilts, or so called “smart beta” strategies, according to BlackRock managing director and former Columbia Business School professor Andrew Ang, speaking at TD Ameritrade Institutional’s National LINC 2016 conference. In other words, it's what he calls “lazy active management."
Looked at another way, of the $3.2 trillion invested in actively managed mutual funds, over $1 trillion would move if the funds were “reverse engineered” and the “lazy” active money converted to “easy” smart beta.
In truth, investing based on factors like value, momentum or size have been known for decades. Graham and Dodd wrote about value investing, and the 1928 book “Confessions of a Stock Market Operator” gives a pretty good primer on momentum investing, he said.
What’s changed is that technology and data allow those factors to be screened efficiently; there’s no need for the visor-wearing stock picker whose time is spent reading thousands of printed reports, and charging high fees for the service.
But if these factors have proven themselves, and technology means everyone can invest in them, shouldn’t the risk premium they provide be effectively erased?
Part of the answer, he said, was that the time line for factor strategies to play out is too long for some investors. “Value will suffer when everything is cheap, and when everything is expensive,” he said. In the mid-1990, value strategies underperformed for over three years as the dot-com market exploded. That keeps out a lot of institutional buyers who have high total return targets to meet.
So the persistence of smart beta strategies requires someone not following the strategies. The persistence of the value premium requires someone to be taking a flyer on more expensive stocks. In order for low volatility factors to prove themselves, other investors have to be chasing the more volatile stocks. “In order for low volatility to be removed as extra return, people would have to change behavior," he said. "So volatility is probably here to stay.”