It happens all the time. A new strategy emerges from the obscure recesses of the research caverns and morphs into an ETF, mutual fund, or a separate account program. Or perhaps it’s outlined on an investor’s blog for all the world to see. Sometimes there are glowing reviews fueled by compelling back-tests. For the most successful strategies that spawn products, there are big inflows of assets. There’s usually plenty of hype too. But when you peel back the details and drill down into the core of the strategy du jour, you’ll typically find a familiar combination of variables: rebalancing with one or more factor tilts.
Product vendors trying to sell new funds don’t like to talk about this, but most of what passes as enlightened money management is linked rather closely with rebalancing the individual holdings back to a fixed-weight benchmark with a particular bias: small-cap and/or value stocks, to cite one of the more popular tilts. I bring this up not to disparage and dismiss active and quasi-active strategies. But I think it’s useful to remind ourselves of what’s usually driving performance in a bid to recognize when “smart” investing is less than it appears.
A simple example is comparing the standard S&P 500 stock market index to an equal-weighted strategy that’s applied to the same pool of companies. As a cap-weighted benchmark, the basic S&P index is commonly described as a “passive” measure of US equities. To some extent that’s true, particularly with regards to rebalancing: there is none. Granted, individual companies come and go in this index for a variety of reasons through time, but let’s ignore that for now. When you buy an S&P 500 ETF, you’re purchasing a strategy with a specific set of rules: no rebalancing, which promotes large-cap and growth tilts.
Source Econo Monitor