Abstract
We document and explain the sharp performance deterioration of smart beta in- dexes after the corresponding smart beta ETFs are launched for investment. While smart beta claims to deliver excess returns through factor exposures, the market-adjusted return of smart beta indexes drops from about 3% “on paper” before ETF listings to about −0.50%~−1% after ETF listings. This performance decline cannot be explained by variation in factor premia, strategic timing, or diminishing returns to scale. Instead, we find strong evidence of data overexploitation in constructing smart beta indexes, which helps ETFs attract flows as investors respond positively to stellar backtests.
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