Smart Beta Investing Awaits Its Advocate

Smart beta is going through some growing pains, and Rob Arnott, co-founder of smart beta shop Research Affiliates LLC and one of smart beta’s pioneers, is a natural candidate to help lead it past these early hurdles. 

The financial industry is littered with fake “innovations” that claim to be a godsend for investors, but in reality are just the latest cash cow for financial institutions. Smart beta, however, may actually be the real thing — if it can deliver on its promise of automating the best of traditional active management and then bring that service, affordably, to investors.

That is precisely what Arnott is attempting to do at Research Affiliates, in collaboration with index provider FTSE Russell. Using the timeless principles of value investing, Arnott has developed indexes that mimic what value investors have attempted to do for generations: beat the market by buying cheap stocks. (Arnott’s smart beta indexes go by the acronym RAFI.)

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Stop Blaming Central Bankers

“My investment returns stink and it’s your fault, central bankers!”

That seems to be the battle cry of long-suffering investors navigating a world of zero interest-rate policies and more recently — gasp — negative interest-rate policies of central banks around the world.

With all the bellyaching about negative interest rates, you would think that investors have nowhere to turn for positive expected returns, but nothing could be further from the truth. The reality is that the returns are out there to be harvested, but investors don’t want to invest where those returns are likely to be. That’s hardly the fault of central banks.

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Fidelity Should Make Smart Beta Smarter

This, I think, was inevitable: Fidelity Investments — the money management behemoth that turned fund managers into rock stars — is entering the smart beta exchange traded fund business with a large-cap, value ETF.

Okay, so it’s not exactly a trailblazing debut. Fidelity spokesman Charlie Keller acknowledged as much, saying that the move merely brings Fidelity “in line with the industry.”

But Fidelity needn’t settle for another me-too lineup of smart beta ETFs. It has the resources and the reach (and the active management cred) to realize the promise that smart beta holds but has yet to deliver to most investors: low cost active management across asset classes and styles. Fidelity should seize the opportunity, for itself and the industry it represents.

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Go Ahead and Hedge the Dollar, Silly

Despite its recent stumbles, the dollar has had the hot hand for much of the last two years. The U.S. Dollar Index, which measures the value of the dollar relative to a basket of foreign developed market currencies, has advanced 18 percent since April 2014.

Conventional wisdom suggests that the dollar isn’t done yet. The Federal Reserve is looking for any excuse to raise interest rates, while Europe and Japan are desperately trying to reboot their economies — a recipe for a stronger dollar.

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Who’s Afraid of Robo-Advisers?

The Massachusetts Securities Division recently fired a shotheard around the robo-adviser world when it declared that the online financial advisers may not be up to snuff as fiduciaries for investors. If that’s the case, it means they may not qualify as investment advisers in Massachusetts.

Regulators must of course hold all financial advisers to a high standard, but robo-advisers – the most investor friendly financial innovation since the index fund – are on the frontlines in the fight for better outcomes for investors. It’s worth considering whether it would be better to improve robo-advisers’ shortcomings rather than discouraging their proliferation.

Massachusetts is the first regulator to suggest that the bots are a problem, but that move follows a growing chorus of commentators and regulators who have raised similar questions. The Securities and Exchange Commission and the Financial Industry Regulatory Authority, for example, jointly cautioned last year that robo-advisers may not provide advice that is right for investors’ financial needs – which is a cornerstone of the fiduciary standard.

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Can Calpers Live With Responsible Returns?

The California Public Employees’ Retirement System recently opened a new chapter in socially responsible investing (also known as environment, social and governance, or ESG, investing) when its investment committee decided to start requiring that the boards of the companies it invests in include climate change experts.

With this move, Calpers is attempting to turn ESG investing on its head. Rather than divest from companies it deems undesirable, it will engage those companies and attempt to improve them from the inside.

Which begs the question: What’s causing Calpers to rethink the traditional levers of ESG investing?

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About Those Hidden Fees Investors Pay

The Department of Labor is soon expected to issue its much-ballyhooed, much-anticipated, and, in some circles, much-loathed “fiduciary rule.”

This rule will require brokers who work with retirement accounts to act as, well, fiduciaries -– in other words, to put their clients’ interests ahead of their own. (Registered investment advisers are already held to a fiduciary standard.)

What could be simpler or less objectionable?

Yet brokers have fought the DOL’s fiduciary rule since it was first proposed last April. The rule is a small part of a larger sea change underway in financial services that will ultimately improve the quality and reduce the cost of investment advice, and brokers who are attempting to buck the trend will end up on the losing side of history.

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Hedge Funds Have a Performance Problem

Hedge funds have had a tough go of it lately. The HFRI Fund Weighted Composite Index – an equal-weighted index of hedge funds – was down 1.1 percent in 2015, and is down another 2.3 percent through February of this year.

It’s not just your workaday hedge funds that have stumbled – the supernovas are burning less brightly, too. Greenlight Capital was down 20 percent in 2015. Hedge funds at Citadel, Blackstone, and Millenium have seen declines this year. And, well, Bill Ackman and Pershing Square’s Valeant debacle.

Granted, every investment has its ups and downs, but investors who dismiss hedge funds’ recent woes as an ordinary cyclical downturn are missing the larger and more worrisome picture.

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The Fed Isn’t Stealing Investors’ Candy

The Federal Reserve’s near-zero interest rate policy has had many far-flung effects, and none more significant than the fattening of the “equity risk premium” (defined as the expectation that stocks will deliver a higher return than “risk-free” investments such as cash).

Amid expectations for rising interest rates, that premium seemed to be on the chopping block. But the Fed breathed new life into it on Wednesday by holding rates steady and saying that it expects fewer rate hikes this year than it initially projected.

Stock investors shouldn’t celebrate just yet. They should instead reconsider whether the equity risk premium is the right gauge for thinking about how much they can expect to get paid for taking risk. Rather than hang on the Fed’s every word to divine the future course of interest rates, they should pay attention to the data and look elsewhere.

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That Financial Advisers Column That Upset You

Gadfly column I wrote last week arguing that financial advisers are subject to inadequate professional standards generated passionate responses from readers who agreed with the thesis and those who did not (including advisers, of course).

Because interest in the column was so intense, I wanted to share some of the critical comments I received from readers, and to explore those comments further.

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