For decades, Burton Malkiel has been a leading advocate of the efficient market hypothesis and its logical extension, the low-cost, passive approach to investing — as outlined in his bestselling book, “A Random Walk Down Wall Street.” Dr. Malkiel is a Princeton economist and Chief Investment Officer of a robo-adviser, Wealthfront.
I had the opportunity to chat with Dr. Malkiel recently about smart beta, his Wealthfront portfolios, and how investors should think about rock-bottom interest rates.
You’ve been a vocal critic of smart beta.
My sense is that the factors behind smart beta are not dependable. Where they may work, they undoubtedly involve more risk. When I have examined the smart beta ETFs that have been in existence, I did not find that – after expenses – they have given investors a better risk-reward tradeoff.
I therefore conclude that it’s probably more that smart beta gives managers an opportunity to charge higher fees, and this is not necessarily good for investors. I remain convinced that a straight capitalization-weighted, broad-based index fund is still the best way for individuals to invest.
What if you could buy a U.S. large cap value ETF for the same low 0.05 percent expense ratio as a Vanguard S&P 500 ETF?
It would clearly be a much better product for the investor and I would certainly like that a lot better. If you were convinced that value was the best way to invest and you could get it for five basis points, I certainly wouldn’t object to anyone buying it.
So, yep, you could do it if you wanted at a low fee, but just be very careful and don’t expect any consistency from smart beta factors even though historically you can find periods where they’ve worked.
Is there a benefit to diversifying across smart beta styles?
If you want a portfolio that has a diversified number of styles, that is the market cap portfolio.
According to MSCI, emerging markets represent 10 percent of the world’s overall market cap, but your Wealthfront portfolios allocate 18 percent of stocks to emerging markets. Why the deviation from market cap?
It’s not a deviation from the market cap portfolio. EM is about – and this is float adjusted – 17 percent of the world market cap. And in fact, to the extent that today institutional investors as a group hold about 4 percent of their portfolio in EM, it’s a reflection of the home country bias. Wealthfront is closer to market cap weighting, which is actually completely consistent with an indexing view.
(Related on ThinkAdvisor: Malkiel: Why Emerging Markets Investing Is Well Worth the Risk)
Also, the Shiller P/E is about 26 in the U.S., which is well above average. It’s about nine for emerging markets, which is well below average. It’s also the case that emerging markets are the cheapest markets in the world.