Four factors of Smart Beta: pros and cons 1. Value, over time, wins “Value stocks” are defined by low price-earnings ratios and low prices relative to book value. Such characteristics would define companies with potential good growth prospects not yet revealed by the market and therefore selling at a low earnings multiples. “Value stocks” are often opposed to “growth stocks”, as it is low earnings multiple to high earnings multiple. While “value” is defined by current market figures, specifically low earnings multiples, “growth stocks” are defined by high earnings growth projections. Earnings growth is however complicate to forecast and investors might easily tend to overvalue “growth stocks”. Further, expectations of high earnings growth …show more content…
In short, in 2009 the RAFI ETF substantially invested (about 15% of its portfolio) in two bank stocks, Citigroup and Bank of America, selling at unusually low earnings multiples. Coming out of the financial crisis, it was uncertain at the time whether banks would avoid nationalization and the strategy involved significant risk. However, the “bet” worked and such an overweighting determined exceptional excess returns. Most likely, this excess return resulted from the extra risk assumed rather than from an imperfection in the cap-weighted Russel 1000. Citigroup and Bank of America stocks were hardly mispriced, rather, their trading price reflected implicit risk factors valued in the market. Equally Weighted Portfolio Strategies A similar story can be told about equally weighted portfolios. The performance chart above compares the Guggenheim Equal Weight 1000 ETF (ticker EWRI) with its benchmark, the Russell 1000 Index. Its six-year history to 2015 illustrate alternating periods of above and below average returns. A slightly superior return of the EWRI ETF is documented. Again, exposure towards the smallest companies confers equally weighted portfolios diversification and risk characteristics that differ from those of capitalization-weighted portfolios, which, to name one, do not require periodic