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Are smart beta funds really smart? Evidence from rational and quasi-rational investor sentiment data

Rahul Verma (College of Business Administration, University of Houston-Downtown, Houston, Texas, USA)
Gökçe Soydemir (College of Business Administration, California State University, Stanislaus, Turlock, California, USA)
Tzu-Man Huang (College of Business Administration, California State University, Stanislaus, Turlock, California, USA)

Review of Behavioral Finance

ISSN: 1940-5979

Article publication date: 21 August 2019

Issue publication date: 12 June 2020

Abstract

Purpose

The purpose of this paper is to examine the relative effects of rational and quasi-rational sentiments of individual and institutional investors on a set of smart beta fund returns. The magnitudes of the impacts of institutional investor sentiments are greater than those of individual investor sentiments. In addition, both rational and quasi-rational sentiments of individual and institutional investors have significant impacts on smart beta fund returns. The magnitudes of the impacts of quasi-rational sentiments are greater than those of the rational sentiments for both types of investors (quasi-rational sentiments of institutional investors have the maximum impact). These results are consistent with the arguments that professional investors consider the sentiments of individual investors as contrarian leading indicators which are mainly driven by noise while conform the sentiments of institutional investors which are driven by more rational factors. A majority of smart beta funds in the sample outperform the S&P500 returns in the short term but fail to consistently beat the market. The authors find evidence that smart beta funds with consistently high returns are relatively less (more) driven by individual (institutional) investor sentiments. Overall, the authors argue that smart beta funds appear to follow quasi-rational sentiments of both individual and institutional investors that are not rooted in economic fundamentals.

Design/methodology/approach

The results of the impulse functions generated from a multivariate model suggest that the smart beta fund returns are negatively (positively) impacted by individual (institutional) investor sentiments.

Findings

The magnitudes of the impacts of institutional investor sentiments are greater than those of individual investor sentiments. In addition, both rational and quasi-rational sentiments of individual and institutional investors have significant impacts on smart beta fund returns. The magnitudes of the impacts of quasi-rational sentiments are greater than those of the rational sentiments for both types of investors (quasi-rational sentiments of institutional investors have the maximum impact).

Originality/value

These results are consistent with the arguments that professional investors consider the sentiments of individual investors as contrarian leading indicators which are mainly driven by noise while conform the sentiments of institutional investors which are driven by more rational factors. A majority of smart beta funds in the sample outperform the S&P500 returns in the short term but fail to consistently beat the market. The authors find evidence that smart beta funds with consistently high returns are relatively less (more) driven by individual (institutional) investor sentiments. Overall, the authors argue that smart beta funds appear to follow quasi-rational sentiments of both individual and institutional investors that are not rooted in economic fundamentals.

Keywords

Citation

Verma, R., Soydemir, G. and Huang, T.-M. (2020), "Are smart beta funds really smart? Evidence from rational and quasi-rational investor sentiment data", Review of Behavioral Finance, Vol. 12 No. 2, pp. 97-118. https://doi.org/10.1108/RBF-08-2018-0084

Publisher

:

Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited