Purveyors of “smart beta” equity portfolio strategies have been very popular over the past few years, both with individual investors and with institutions.

The source of the attraction is clear:

smart beta claim to provide better performance than an index fund without engaging in active portfolio management. Actually, it claims to outperform because it doesn’t employ value-subtracting human portfolio managers to muck up the works.  Rather, smart beta operates by reshaping the weightings of stocks in the index according to predetermined computer-managed rules.  (I’ve written about smart beta in more detail in other posts.)

In other words, it’s free lunch.

My observation is that smart beta is a marketing gimmick  …one that has been very successful in bringing in new money, but a gimmick nonetheless.  Basically what it does is to create a portfolio that contains the index constituents, but in different proportions from their index weightings.  The rules for determining the smart beta weightings are set in advance and the portfolio is periodically rebalanced to restore the “correct” proportions.  For my money, the preceding sentence describes active management.  The portfolio managers are just hidden behind a computer curtain.

A simple example of smart beta:  maintain a portfolio of S&P 500 names but have .2% of the money in each stock–rather than having it loaded up with lots of Apple, ExxonMobil, Microsoft, Johnson&Johnson and Berkshire Hathaway.  Historically, this is a strategy that had its best run in the late 1970s – early 1980s, but which followed with a very extended period of sub-par performance.

Anyway,

I was catching up on my reading of the Financial Times over the weekend and came across an article from the FTfm of February 2nd titled,“Smart beta is no guarantee you will beat the market.”

It turns out that of the 10 biggest smart beta ETFs in the US, seven have underperformed over the past three years and five over the past five years.

That’s not that different from what active managers have done.

However, unlike the case for active managers, assets under smart beta management have grown fivefold since 2009.