Alpha or Assets? Factor Alpha vs. Smart Beta

O’Shaughnessy Asset Management

Patrick O’Shaughnessy

Research

12 Pages

O’Shaughnessy Asset Management examines why many smart beta strategies prioritize scalability over excess returns, arguing concentrated factor investing offers stronger long term advantages. The paper challenges asset gathering incentives across asset management and suggests crowded factor trades may weaken future performance as assets expand.

Key Takeaways

Scale Reduces Alpha: Portfolios holding 50 stocks materially outperformed 500 stock versions, suggesting broader diversification diluted valuation factor effectiveness across the S&P 500 universe.
Valuation Spread Matters: The paper contrasts paying 0.75% fees for stocks trading at 12x earnings versus 0.05% fees for markets trading near 25x normalized earnings in March 2016.
Crowding Weakens Factors: Price to book performance deteriorated significantly after 1992, with cumulative excess returns flattening as factor adoption and institutional capital increased.
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