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My Top 4 Take-Aways From the Morningstar ETF Conference (Part 2)

Alpha is a sideshow; Never quit

Ben Johnson 20.10.2016

Alpha Is a Sideshow

Jason Hsu, chairman and CEO of Rayliant Global Advisors and co-founder of Research Affiliates, is widely recognized as one of the pioneers of “smart beta.” Hsu began his conference presentation by retracing the benefits of this marriage between the positive attributes of active (an opportunity for, but by no means a guarantee of, outperformance) and passive (transparency, low costs) approaches to portfolio management. In its essence, Hsu argues that strategic beta is just “low-cost factor investing.”

While the democratization of low-cost factor investing has been a generally positive development for investors of all stripes, early indications are that this phenomenon is carrying with it some old baggage. Specifically, Hsu showed that “timing woe,” as he calls it, is everywhere. Hsu and his Research Affiliates colleagues documented this “woe” in a research paper that was first published last year.3

What they call woe Morningstar regulars will know as the “behavior gap” that my colleague and Morningstar FundInvestor editor Russ Kinnel has documented for years in his annual “Mind the Gap” study. Both studies lay bare a sometimes vast differential between the returns that funds experience (time-weighted returns) and those that investors, on average, experience (cash-flow-weighted returns). This gap is tantamount to a self-imposed behavioral cost, and it is every bit as present and persistent in low-cost factor funds as it is in high-priced active strategies.

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About Author

Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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