Ari Polychronopoulos, CFA of Research Affiliates just released an excellent new white paper on the potential benefits of combining different Smart Beta strategies. Specifically, he looked at combining Fundamentals Weighting, Low Volatility, and Momentum.
PERFORMANCE AND CORRELATIONS
The three smart beta strategies under consideration produce results with very different characteristics. Table 1 compares the performance, volatility, tracking error, Sharpe ratio, and information ratio of the simulated strategies over the 47-year period from 1967 through 2013. All three outperformed a cap-weighted benchmark, the S&P 500 Index, by approximately 2% to 3% per annum over the measurement period. As one would expect, low volatility has the lowest standard deviation of returns, and momentum has the highest. Because the percentage reduction in volatility is much greater than the percentage decline in return, low volatility yields the highest Sharpe ratio; but it also has the lowest information ratio due to its high tracking error vis-à-vis the cap-weighted index. The fundamentally weighted strategy most resembles the cap-weighted index in that its volatility is closest to the overall market and it has the lowest tracking error.
My emphasis added. All three strategies outperformed the S&P 500 over this time by healthy margins. But, an equally-important part of his research shows the correlation of returns in excess of S&P 500 returns.
What is this telling us? It is reflecting the fact that these three factors, which independently outperformed the S&P 500 over time, outperform at different times. The result: meaningful diversification!
Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. This example is presented for illustrative purposes only and does not represent a past recommendation. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. See www.powershares.com for a prospectus.
[…] Building Better Beta [Systematic Relative Strength] Ari Polychronopoulos, CFA of Research Affiliates just released an excellent new white paper on the potential benefits of combining different Smart Beta strategies. Specifically, he looked at combining Fundament… […]
Different factors overlapping effect on diversification is a common fear of money managers. Good paper.
http://nightlypatterns.wordpress.com
What I have felt all along!!!! Thnak you and ” take that Vanguard old man”
[…] are not the only investment manager that employs a systematic investment process (think about the array of Smart Beta strategies). But the larger point should be clear, consistency is a not a commodity in ample supply and yet […]