What Breaking Bad teaches you about smart-beta funds

Breaking Bad is a TV series that ran for five series from January 2008 to September 2013. It charts the life of Walter White, a mild-mannered chemistry teacher whose world is turned upside down when he is diagnosed with lung cancer.

In an effort to cover the cost of treatment and secure his family's financial future, he joins forces with former pupil and small-time drug dealer Jesse Pinkman to manufacture methamphetamine. Over time, White becomes a ruthless drug lord, teaming up with drug cartels to expand his market.

The key moment

Early on, White attempts to make meth for the first time in a camper van he has bought for the purpose. Initially, Pinkman scoffs at his partner's insistence on using proper procedures, with precise measurements and proper equipment, favouring a more "artistic" approach.

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At the insistence of his former teacher, Pinkman reluctantly follows the instructions. When he samples the final product, Pinkman is amazed at its quality and exclaims "This is this is art, Mr White!" "Actually, it's just basic chemistry," White retorts.

Lessons for investors

Just like White, some in the fund-management industry aim to apply basic science to improve its products. Their "smart-beta" funds aim to beat the market, just as active fund managers do.

However, they eschew the art of stockpicking in favour of a scientific approach that combines the low cost of passively tracking stock indices with stock-picking strategies that have been shown in academic studies consistently to beat the market, such as value investing. Because smart-beta funds automatically follow set criteria, they eliminate the need for a human manager. This should keep fees low and eliminate human biases.

There are three types of smart-beta fund. One group aims to replicate a market index, but in a slightly different way from the traditional method of weighting by market capitalisation. For instance, they might allocate shares in their portfolio according to earnings or dividends.

A more "active" group only buys stocks that perform best against certain criteria. Some funds go further by screening and ranking stocks by multiple criteria. However, the more elaborate the approach, the higher the fees, and the lower the cost advantage. Whether such strategies will make investors as stinking rich as Walter White became remains to be seen.