Smart Beta Factor Investing: Is the Vast Amount of Equity Return Factors Economically Justifiable with Respect to Smart Beta Investing from an Investor Perspective and to what Extent do Macroeconomic Forces Explain Smart Beta Performance?

Sara Hassanzadeh & Felix Gerrit Lüdtke

Student thesis: Master thesis


This paper guides the reader through the Smart Beta “factor zoo” to unveil the notably smartest strategy based on a risk-adjusted analysis. The strategies analysed are Dividends, EarningsWeighted, Equal-Weighted, Fundamentals, Growth, Low Volatility, Value Momentum, Multifactor, Non-traditional and Quality. A gap in literature is filled by examining the relationships between the return performance of these eleven SB ETF strategies and a series of eight macroeconomic indicators. An empirical study, consisting of 327 ETFs form the crucial basis of whether US Smart Beta ETFs are able to beat their passive benchmark. Two weighting schemes - equally- and size-weighted portfolios – are constructed to compare SB performance with a raw and risk-adjusted benchmark. Only two categories, value and multi-factor are found to consistently outperform in both the equally- and size-weighted portfolio. However, it is the equally-weighted portfolio that provides more significant alphas relative to its benchmark suggesting a better performance of smaller SB ETFs. Unexpectedly, the well-established Fama-French factors size (SMB) and value (HML) proved to have no explanatory power and as a result are dropped from the analysis. Within the macroeconomic factors, only four (GDP, IPI, UR, CPI) are statistically significant in explaining SB ETF excess returns. A principle component analysis reduced the dimensionality from eight to only three independent variables without sacrificing much explanatory power and verified the importance of GDP and IPI in explaining SB ETF excess returns. Nonetheless, one of the most critical points throughout literature is confirmed in the analysis. The promising concept of SB fund managers to tilt their portfolios towards specific (or a combination of) equity factors is attractive to investors only in case of few selected strategies. When taking expenses into account, the superior performance of SB factors seems too unreliable to recommend SB ETFs as an attractive investment vehicle to investors. Lastly, SB outperformance seems to be diminishing since inception for most SB factors – as are Smart Beta ETF fees.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2019
Number of pages163