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'Smart Beta is not Monkey Business': ERI Scientific Beta warns against simplistic explanations of smart beta performance in a new research paper
In new research published in the latest issue of the , entitled "Smart Beta is not Monkey Business," ERI Scientific Beta has rejected the claims of "monkey portfolio" proponents, who argue not only that all smart beta strategies generate positive value and small-cap exposure, which fully explains their outperformance, but also that similar results are obtained by any random portfolio strategy, including the inverse of such strategies. The "monkey" label comes from the idea that a monkey would be able to generate similar performance through a random selection of stocks.
The ERI Scientific Beta paper analyses these claims using test portfolios which follow commonly-employed methodologies for explicit factor-tilted indices. The results directly invalidate all of the above claims. In particular, the results show that .
In addition, and perhaps reassuringly, the inverse of these strategies generates inferior performance. That the findings directly contradict the monkey portfolio claims can be explained by the set of test portfolios. While the monkey portfolio arguments may hold for the particular smart beta specifications tested by its proponents, they do not hold in general. Specifically, the research conducted shows that only the indices termed "fundamental" behave like monkey portfolios, on the one hand because their method of construction is based on accounting criteria that are not associated with any statistically significant risk premium over the long term, and on the other because their high level of concentration results in a large proportion of specific risk that leads to performance that lacks robustness and is therefore random.
. For the explicit factor-tilted strategies tested in this new research, the results imply that as such strategies do not behave like "monkey" portfolios.
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