Smart beta seems to have lots of fans these days, and the indexing strategy’s detractors are generally less audible.
Not so Ron Surz, a veteran index creator, who is particularly critical of PowerShares’ Fundamental Pure Style (FPS) indexes.
“When you value-tilt a growth index, you just turn it into another value index. That kind of fundamental weighting is, well, stupid,” he tells ThinkAdvisor in a phone interview.
The ThinkAdvisor contributor and president of Orange County, California-based pension consulting firm PPCA finds fault with his cross-county rival Research Affiliates’ propensity to tilt toward small-cap and value stocks.
He admits that weighting has outperformed in the past, but says “it’s not a slam-dunk guarantee of better [future] performance.”
Citing Research Affiliates founder Rob Arnott’s dictum about weighting an index by anything other than price, Surz asks rhetorically:
“So why don’t you weight by earnings growth?”
In other words, smart beta shouldn’t have to be value-oriented, as Arnott’s indexes are, in order to break the link between price and weight to which both indexers object.
And it is PowerShares’ FPS indexes that epitomize to Surz how smart beta flunks the investment IQ test.
“The large-cap growth portfolio is right on top of the large-cap value in terms of its characteristics [i.e., they’re essentially the same],” he says.
“The mid-cap growth portfolio is more defensive than the mid-cap value fund, and it’s the same story with the small-cap growth portfolio, which has a lower P/E than the small-cap value portfolio,” he says.
Smart beta has “made a mush of the growth indexes,” he adds.
The veteran indexer discloses a personal history involving the contrasting approaches he and Arnott take and PowerShares.
“I was actually having conversations with PowerShares seven years ago,” he recalls. “They already had style indexes that were not attracting assets, and they decided they needed to change the game.”
After thoroughly vetting Surz’s indexes, “they went with Arnott, trying to capitalize on smart beta; it was hot. He built it for PowerShares. The bottom line: it’s marketing; it clearly wasn’t thought through,” Surz says, referring to what he views as the lack of differentiation among the style indexes.