Journal of Financial and Quantitative Analysis Vol. 59 No. 6 2024

The Smart Beta Mirage

Shiyang Huang¹; Yang Song^2,1; Hong Xiang^3,1

¹ University of Hong Kong · ² University of Washington · ³ Hong Kong Polytechnic University

Abstract

We document and explain the sharp performance deterioration of smart beta indexes after the corresponding exchange-traded funds (ETFs) are launched for investment. While smart beta is purported to deliver excess returns through factor exposures, the market-adjusted return of smart beta indexes drops from about 3% “on paper” before ETF listings to about −0.50% to −1% after ETF listings. This performance decline cannot be explained by variation in factor premia, strategic timing, or diminishing returns to scale. Instead, we find strong evidence of data mining in the construction of smart beta indexes, which helps ETFs attract flows, as investors respond positively to backtests.

DOI

10.1017/s0022109023000674

Volume

59

Issue

6

Pages

2515-2546

Language

en

Sources

openalex bibtex:phds-export.bib crossref

Cite

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