New Listing

Academics failed, claims new ETF designed to "outsmart smart beta"

David Tuckwell

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In the land of smart beta - some beta is smarter than others. But one new ETF claims to be the smartest beta of them all.

The newly listed Reality Shares Fundstrat DQM Long ETF (DQML), created as a joint venture between Reality Shares and research house Fundstrat, promises to "outsmart smart beta".

DQML will track a proprietary index built by Fundstrat. The fund claims to take "multi-factor investing to a new level" and leave the competitor multi-factor funds in the dust.

In order to outsmart its competitors, DQML will track an index composed of eight "factor groups". These include four fundamentals: cash flow, credit income statements and balance sheet. And four market metrics: momentum, sentiment, laggards and valuations (PE, PB, PS, etc.).

The top scoring 100 companies based on these metrics are put in the index and equally weighted. But the relevance of each factor is adjusted depending on which sector companies are from.

"Academics failed to realise that factors have varying degrees of statistical significance on a stock by stock basis," Tom Lee said in a presentation.

"As experienced equity analysts we recognised that each key… factor group must have a different importance for each sector."

As an example, Fundstrat says that valuations matter more for financials like banks than they do for tech companies.

A backtest claims the index has delivered 730bps of alpha a year the past 26 years. No information about transaction costs and taxes - a known killer of smart beta strategies - was mentioned by Fundstrat.

Analysis - Will the fund match its own hype?

Every issuer wants their newly listed ETFs to make a splash. But each issuer goes about it in different ways.

Going through the promotional material, Reality Shares and Fundstrat have called DQML: a "huge deal", "outsmarting smart beta", "takes multi-factor investing to a new level", because "academics failed". While the index manager Tom Lee is described as "famous," an "industry heavyweight" and an "experienced equity analyst".

Everyone is entitled to a bit of self-promotion. But the aggressive approach can have risks-- most crucially, that the fund will fail to match its own hype.

Psychologists tell us that almost everyone thinks they're smarter, more handsome, better at driving and more likeable than they really are. (Interestingly the people best at guessing their own abilities are manic depressives).

The narcissism is - of course - is particularly pronounced in financial services. Every manager believes their fund will beat the index. Every ETF provider believes their fund is the best. They can't all be right.

Which brings us back to DQML.

Have academics really failed? Will DQML's index generate 730bps of alpha a year once it's live? Is Fundstrat's "famous" Tom Lee really able to "outsmart" the quants at Vanguard, BlackRock and the rest (are they not talented too)?

Whether this fund matches its own hype we'll have to wait and see.

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