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Portfolio > Portfolio Construction

Barry Ritholtz Explains Why He’s a Smart Beta Skeptic

By Emily Zulz

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Barry Ritholtz doesn’t hate smart beta, but one could definitely call him a skeptic.

ETF.com CEO Dave Nadig sat down with Ritholtz, chief investment officer of Ritholtz Wealth Management, during the Inside Smart Beta conference in New York City to find out why Ritholtz is a skeptic of smart beta and why he hasn’t poured client assets into these strategies.

Here are some highlights from that conversation.

Ritholtz explained his investment philosophy, and why good investing is boring.

Ritholtz’s philosophy: Behavior is more important than individual stock picks and asset allocation.

“You can have the greatest portfolio ever, and if you panic in March ’09 and sell, and don’t get back in because the markets run away from you, it doesn’t matter how good your portfolio is,” he explained.

Ritholtz said that his firm tries to make sure clients understand very early in the process how important it is not to be their own worst enemy. At the same time, they combine this education with financial planning.

“By the time we get to the question of: ‘What should my portfolio look like?’ You’re not fetishizing alpha, you’re aiming for specific financial outcomes down the road that meet your retirement, generational wealth transfer, philanthropic needs,” Ritholtz explained.

According to Ritholtz, the people that are thinking “I’m looking for a specific Sharpe ratio and here’s the sort of returns I want” are probably not going to be the best fit for the firm.

“Other people say: ‘Here’s where I want to be in 5, 10, 20 years. How can you help me get there?’ That’s the sort of client where alpha and beta don’t matter as much as creating a portfolio that matches exactly what they’re looking for,” Ritholtz explained.

When Nadig interjected that this philosophy sounded “really boring” and “dull,” Ritholtz agreed with him.

“Good investing should be boring as s—,” Ritholtz explained. “If you’re investing is exciting, you should be at the racetrack or Vegas because you’re not investing. Speculation is exciting. Gambling is exciting. Good investing, boring as hell.”

True smart beta should be called fundamental indexing, according to Ritholtz.

Some papers say there are 500 factors, whereas other research says there could be up to 1,400 factors, Ritholtz said.

However, according to Ritholtz, most of these factors aren’t true factors.

“There’s only so many things that are actually factors that will produce additional return, without adding an enormous slug of either additional risk or illiquidity,” he explained.

True smart beta should really be called “fundamental indexing,” he said.

“If you want to have some portion of your portfolio in active strategies, or in smart beta, or whatever floats your boat, I don’t have a problem with it,” Ritholtz said. “The concern is, at what point does it become one shiny object after another?”

Most active trading decisions are bad, Ritholtz says.

Ritholtz and his firm will occasionally make active calls — like when they did a “heavy-thumbed rebalancing,” as Ritholtz calls it, a few years ago and switched from a 52% U.S. and 48% overseas allocation to a 48% U.S. and 52% overseas allocation — but Ritholtz stresses they aren’t active.

“A lot of this comes back to, how good are you going to be at active decision making?” he said. “When we look at the history of active trading, over long periods of time the more decisions you make, the greater the odds are that one of those decisions is going to be bad. Really, most of those decisions are bad.”

According to Ritholtz, a big part of the firm’s philosophy is “don’t just do something, sit there.”

“And that’s very hard for humans to do,” he added.

If he had to choose, Ritholtz said he would choose smart beta over traditional active management.

Comparing smart beta to straight-up indexing, Ritholtz think there’s a “slight cost disadvantage to the greater turnover, the greater expense for on average most of the smart beta world.”

However, when looking at smart beta against the universe of active managers, Ritholtz said that many of the active managers have “very low active share and are essentially closet indexers.”

If Ritholtz had to choose between an “active fund where it’s a committee picking their best ideas” or a “fundamental index based on price-to-book or dividend,” he said he would go with the fundamental index.

— Check out Here Are Some of the Most Epic Mistakes by Famous Investors: Michael Batnick on ThinkAdvisor.

Emily Zulz

@think_emilyz

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