MIB: Avoiding the Behavior Performance Penalty

How can investors use inexpensive index strategies yet still generate returns that outperform the markets?

According to Chris Brightman, chief investment officer and partner at Research Affiliates, the solution to that particular challenge is the combination of fundamental indexing and factor investing. In our Masters in Business conversation this week, he notes that “smart beta” allows for simple, transparent and inexpensive index strategies that are not market-cap weighted.

Brightman call this a “simple, elegant way to pursue a contrarian approach” that is more akin to cap-weighted indices than expensive active stock selection. It also has the benefit of keeping emotions out of the process of selecting and rebalancing individual equites. Bad behavior leads to an average annual under-performance of 200 basis points versus the broad indices. By deploying a systematic approach to indexing, investors avoid this performance penalty.

In our conversation, we discuss the under-performance of value stocks, and how why they tend to be so cyclical. Every long-term study that looked at the value versus growth question historically has confirmed value eventually will outperform growth around the world. The issue is that long time line, which eventually leads investors to becoming bored and shifting away from value. Brightman adds that Value’s outperformance comes from some assumption of additional risk, as well as investor’s behavior.

Previously, Brightman was a member of the Investment Fund for Foundations (TIFF), the Virginia Retirement System, the University of Virginia Investment Management Company, and Strategic Investment Group. Previously, Brightman ran money for the University of Virginia endowment.

His favorite books are here; A transcript of our conversation will be available here.

You can stream/download the full conversation, including the podcast extras on Apple iTunesBloombergSpotifyGoogle PodcastsOvercast, and Stitcher. All of our earlier podcasts on your favorite hosts can be found here.

Next week, we speak with Andrew Ang, director of BlackRock’s $210 billion dollar factor strategies group. The former Professor of Finance at Columbia Business School is the author of Asset Management: A Systematic Approach to Factor Investing.



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