How Smart Are Smart Beta Exchange-Traded Funds? Analysis of Relative Performance and Factor Exposure

Using a sample of 164 smart beta exchange-traded funds (ETFs) during 2003–2014, I analyze whether these funds beat their benchmarks by tilting their portfolios to various factors. I also test if smart beta funds harvest factor premiums more efficiently than their traditional cap-weighted benchmarks by periodically trading against price movements. I find no conclusive evidence to support the hypothesis that smart beta ETFs outperform their benchmarks on a risk-adjusted basis. Performance of smart beta funds is also insignificant relative to the risk-adjusted blended benchmark consisting of existing cap-weighted funds that provide passive exposure to market, size, and value factors. Smart beta ETFs exhibit potentially unintended factor tilts offsetting the return advantage from intended factor tilts. Performance attribution analysis demonstrates that static factor exposure rather than systematic rebalancing is the main driver of smart beta performance