Pioneer Of 'Smart Beta' ETFs Warns----Trade Too Crowded, Crash Is Coming

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By Brett Arends at MarketWatch

And there’s a further, dangerous twist. As an investment fashion becomes more popular, people drive up the price. But as they drive up the price, they then start factoring that extra bump in valuations into their forecasts for the future. So people get even more bullish while they should be getting bearish. It’s like jumping on a seesaw at the top and thinking it’s going to keep going up.

Arnott’s latest research paper is a salutary warning that smart beta, like anything, is subject to the basic laws of financial gravity, generally known in the trade as “mean reversion.” If you wanted to bet against it, you’d go out right now and buy the lowest-quality stocks, on the basis that they are out of fashion and therefore the best relative bargain.

There are, however, less drastic alternatives. Arnott finds that simple, old-fashioned “value” strategies — which invest in the stocks that are cheap in relation to present profits and dividends — look like a bargain now. Value stocks have outperformed growth stocks by around 3 percentage points a year over the long term. But they are currently near historic lows in relative terms.

“The value effect is … in its cheapest decile in history,” he says. Value is out of fashion, partly because it’s looked bad for the past seven or eight years, and partly because investors have become excited by smart beta instead.

Or, as always, one could simply pick a random collection of stocks and invest an equal amount in each one. Equal-weight strategies, like value, have beaten the traditional indexes over the long term. And they would seem to be immune from fashion, because they don’t weight anything at all.

Source: Opinion: 'Smart-Beta' Investing Guru is Now Warning of a Crash - MarketWatch

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