University of Oulu

Smart beta ETFs risk-adjusted performance relative to broad market portfolio and passive/active peers

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Author: Anttila, Niko1
Organizations: 1University of Oulu, Oulu Business School, Department of Finance, Finance
Format: ebook
Version: published version
Access: open
Online Access: PDF Full Text (PDF, 1.3 MB)
Pages: 56
Persistent link:
Language: English
Published: Oulu : N. Anttila, 2023
Publish Date: 2023-11-15
Thesis type: Master's thesis
Tutor: Sahlström, Petri
Reviewer: Sahlström, Petri
Kallunki, Juha-Pekka


The purpose of this thesis is to examine the risk-adjusted performance of smart beta ETFs in comparison to both passive and active peers, as well as in relation to broad market portfolio. Smart beta ETFs are designed around academically supported risk-factors/anomalies, such as value, size, and profitability, which have historically exhibited outperformance in comparison to broad market. By targeting these risk-factors, smart beta ETFs attempt to deliver better risk-adjusted returns and enhanced diversification in comparison to traditional, market capitalization weighted index funds.

Utilizing CAPM and Carhart four-factor model regressions, we find that smart beta ETFs fail to outperform the broad market. On the contrary, when we compare the number of smart beta funds linked to negative alpha as opposed to positive alpha, the negative ones dominate, indicating inferior performance in comparison to market. This result holds whether we control for risk-factors beyond the market or not and persists also in comparison to passive peers.

Essentially, our results suggest that pursuing the goal of smart beta strategies, aimed at capturing the returns tied to alternative risk-factors beyond the market beta, comes at a (slight) cost. From an assetpricing perspective, investors can gain heavier exposure to these risk-factors through smart beta ETFs, yet by doing so, they sacrifice a portion of the excess-returns tied to those factors. However, when contrasted with active funds, smart beta funds exhibit signs of outperformance.

The examination of relative risk and return statistics, including Sharpe ratio, Sortino ratio, and maximum drawdown, produce consistent results. When the funds are ranked based on these ratios, the order is from passive funds to smart beta funds to active funds. This implies that smart beta ETFs are typically less (more) diversified than their passive (active) peers.

The practical implication of our study lies in urging investors to carefully assess whether the benefit gained from increased exposure to any specific factor outweighs the cost associated with capturing such exposure. Furthermore, for investors who are contemplating between investing in a factor-focused smart beta or active fund, our findings indicate that smart beta is generally a better alternative. This is based on their dominance in terms of risk-adjusted returns and diversification.

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Copyright information: © Niko Anttila, 2023. Except otherwise noted, the reuse of this document is authorised under a Creative Commons Attribution 4.0 International (CC-BY 4.0) licence ( This means that reuse is allowed provided appropriate credit is given and any changes are indicated. For any use or reproduction of elements that are not owned by the author(s), permission may need to be directly from the respective right holders.