On a recent Friday afternoon, Andrew Ang sits in a drab conference room on the seventh floor of BlackRock's midtown Manhattan headquarters and seems exasperated by the recent debate raging over "smart beta," the investment craze he has helped spread.
It's the practice of training computers to screen broad market-cap-based indexes for "factors" like low P/Es and 12-month price momentum, in an effort to improve returns.
The strategy, which is sometimes called "strategic beta," has reached investment-fad status among financial firms, with $620 billion devoted to it in more than 600 exchange-traded products. In just the past 24 hours, Vanguard founder Jack Bogle has railed against it, saying smart beta "makes claims that are beyond its ability to fill." Even smart-beta pioneer Rob Arnott, whose firm's investment strategies are used to manage $179 billion, is now worrying that smart beta could go "horribly wrong."
Undeterred and sounding like a salesman, Ang tees off: "Don't you want to buy cheap, buy high-quality names, find, identify and participate in trends? It's the language of investment excellence." He adds, "What is new is we can package these insights in a more transparent, cheaper and easier-to-access way."
For Ang, a former senior finance professor at Columbia University, the argument is not academic. He runs factor investing at BlackRock and oversees $173 billion that includes $87 billion of smart-beta exchange-traded funds, making BlackRock the world's biggest provider of smart-beta ETFs.
BlackRock, which manages $5.4 trillion, has been firing human stock pickers and betting that factor investing is the future of the struggling active-investment-management business.
Disappointed with mutual fund managers and hedge funds, investors have rushed into these strategies, which aim to fuse the low fees and transparency found in passive investments that match the market's return (beta) with the market-beating goals of active management.
Ang expects there to be $1 trillion invested in smart-beta ETFs by 2020, and he has focused BlackRock's offerings on six factors: small size, value, dividend yield, momentum and quality for return enhancement, and low volatility to reduce risk.
Forget about Peter Lynch and ten-bagger stocks. Ang, a Star Trek nerd with a Ph.D., is the face behind the faceless future of active management.
At 44, he has been researching factors for 20 years. Born in Malaysia, Ang is the son of a delicatessen owner and physical therapist and grew up in Perth, Australia.
To earn his doctorate from Stanford University, he wrote a dissertation that focused on factor investing. Ang was immediately offered a job running factor-based investments at Barclays Global Investors in 1999, but he turned it down.
Instead, he headed to New York, where in addition to his professorial duties he would consult for Peter Muller's quant trading shop, PDT.
He also did work for sovereign wealth funds on diversifying portfolios across factors that drive returns, as opposed to asset classes like stocks and bonds.
The approach resonated after asset-class diversification failed to protect portfolios from the financial crisis.
Ang argued convincingly that factors were the nutrients of asset classes and their risks needed to be understood just as with food.
By the time Ang showed up for a meeting with senior BlackRock strategists in 2015, factor investing had gone mainstream and a large swath of it became known as smart beta.
A paper co-written by Ang had shown that the most volatile stocks have abysmally low risk-adjusted returns, sparking a wave of so-called low-volatility ETFs designed to avoid those stocks and replicate market returns with less risk.
BlackRock was churning out ETFs that cheaply tracked indexes tied to certain factors, and its low-volatility ETF, with an expense ratio of 0.15%, had become wildly popular. BlackRock CEO Larry Fink, who had built the firm's ETF business by buying Barclays Global Investors, essentially offered Ang the same job in 2015 he had declined 16 years earlier.
"I realized in order to bring factor investing to a wider audience you can't operate out of an ivory tower and engage a couple of institutions," Ang says.
Ang's faith in factors is based on back-tested returns on decades of data, but there is always the danger such evidence is flawed. So Ang says he also requires an economic rationale that is rooted in tried-and-true financial theory. "Graham and Dodd were geniuses who were the first to do value and quality in 1934," Ang says.
"These concepts have been well studied, but with technology we can gather this information, analyze it and trade with better execution." Ang says trying to operate like Ben Graham today would be "like trying to write a play with a quill because Shakespeare used to."
To date BlackRock's most popular smart-beta ETFs have been its dividend-stock-weighted indexes like iShares Select Dividend ETF and its low-volatility funds, like iShares Edge MSCI Min Vol USA ETF.
Ang compares creating a factor-based index for an ETF to constructing a Lego building that looks different from what is pictured on the box. BlackRock has used the "Lego blocks" to build multifactor stock ETFs--which might, for example, overweight price momentum and small size--that can serve as one-stop shops.
Most of BlackRock's factor ETFs rely on factor indexes developed with MSCI, whose Barra unit has been doing work for quant shops for decades.
According to Ang, single-factor ETFs should be used to complement an existing portfolio that doesn't have exposure to all the available sources of returns or to replace underperforming active managers. He currently favors value and momentum ETFs and thinks it makes sense to tilt toward some factors over others during certain periods in accordance with different signals.
That puts Ang right in the middle of the war of words that has been waged by pillars of the smart-beta set: Arnott, whose firm builds factor indexes and recommends market-timing factors, and billionaire Cliff Asness, who runs $188 billion AQR Capital and thinks factor timing is nearly impossible.
Burton Malkiel, Princeton economist and author of the investment classic A Random Walk Down Wall Street, is more blunt. "Smart beta may not be smart investing," he says. "BlackRock has realized stock-picking active management hasn't worked--so is there some way to continue to get the fees?"
There are also questions about how much capacity these increasingly popular strategies can handle, and some risk managers, like Richard Bookstaber at the University of California, are worried there won't be enough natural liquidity providers if investors suddenly head for the exits. "It's a flavor-of-the-month sort of thing," he says, "and in terms of scenarios that I am modeling, it's one of the biggest concerns right now."
Ang responds that smart beta represents a tiny sliver of the S&P 500 today and that the marketplace is getting more robust with product offerings.
He can also point to the five-year track record of BlackRock's flagship low-volatility ETF, which has pretty much done what it was created to do and returned 14.5% annualized, nearly matching the 14.8% return of the S&P 500, with less risk.
What's next? Ang and BlackRock would like to see smart beta play a major role in retirement plans. He has already launched nine target-date factor mutual funds and three smart-beta bond ETFs. Two more smart-beta bond ETFs are on the way.
"Factors are the core elements of what the best active investors have been doing for a very long time," Ang insists. "For active managers the pace of innovation is only going to accelerate."
