'Smart Beta is not Monkey Business': ERI Scientific Beta warns against simplistic explanations of smart beta performance in a new research paper

NICE, France, April 4, 2016 -- In new research published in the latest issue of the Journal of Index Investing, entitled "Smart Beta is not Monkey Business," ERI Scientific Beta has rejected the claims of "monkey portfolio" proponents, who argue not only that all smart beta strategies generate positive value and small-cap exposure, which fully explains their outperformance, but also that similar results are obtained by any random portfolio strategy, including the inverse of such strategies. The "monkey" label comes from the idea that a monkey would be able to generate similar performance through a random selection of stocks.

The ERI Scientific Beta paper analyses these claims using test portfolios which follow commonly-employed methodologies for explicit factor-tilted indices. The results directly invalidate all of the above claims. In particular, the results show that many smart beta strategies display exposure to factors other than value or small cap, as well as pronounced differences in factor exposures across different strategies.

In addition, and perhaps reassuringly, the inverse of these strategies generates inferior performance. That the findings directly contradict the monkey portfolio claims can be explained by the set of test portfolios. While the monkey portfolio arguments may hold for the particular smart beta specifications tested by its proponents, they do not hold in general. Specifically, the research conducted shows that only the indices termed "fundamental" behave like monkey portfolios, on the one hand because their method of construction is based on accounting criteria that are not associated with any statistically significant risk premium over the long term, and on the other because their high level of concentration results in a large proportion of specific risk that leads to performance that lacks robustness and is therefore random.

An important implication of the results is that one should take care to avoid over-generalising from testing particular specifications of smart beta. For the explicit factor-tilted strategies tested in this new research, the results imply that a careful assessment of investment philosophy and index design is indeed relevant as such strategies do not behave like "monkey" portfolios.

As part of its policy of transferring know-how to the industry, EDHEC-Risk Institute has set up ERI Scientific Beta. ERI Scientific Beta is an original initiative which aims to favour the adoption of the latest advances in smart beta design and implementation by the whole investment industry. Its academic origin provides the foundation for its strategy: offer, in the best economic conditions possible, the smart beta solutions that are most proven scientifically with full transparency of both the methods and the associated risks.
ERI Scientific Beta, 1 George Street, #07-02, Singapore 049145. For further information, please contact: Séverine Cibelly, Tel.: +33 493 187 863, E-mail: [email protected], Web: www.scientificbeta.com.

Press_release_Smart_Beta_Monkey_Business http://hugin.info/157174/R/2000399/737961.pdf

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