and build their own founder-CEO set of holdings and invest alongside existing U.S. large-cap holdings. In either situation, the intent and implementation should be the same: Fund managers weight companies run by founder CEOs in a more concentrated manner (than currently applied) and assume risk exposures associated with this decision. 69 Incorporating a founder-CEO index overweight in a U.S. large-cap growth portfolio utilizes a logical argu- ment coupled with strong analytical support. We provide powerful evidence that leadership matters: U.S. large- cap growth companies run by founder CEOs (during our period of study) yield superior performance while the founder CEO is in control, and the excess perfor- mance cannot be easily justified by other well-known style or sector factors. But buyers beware. Investors who follow a smart beta portfolio employing higher weights to founder CEO–run companies should not expect better performance every year. Our analysis reveals that return patterns vary greatly and may be subject to peri- odic disappointment. However, for investors willing to embrace a modest increase in risk and hold their strategy for an extended period of time, our results demonstrate that the incremental risk may well be worth it. 1 Jacobs and Levy [2014] recognized that smart beta strategies are swiftly gaining market share and cited a Sep- tember 6, 2013 Financial Times article, “Smart Beta Band- wagon Triggers Alarm,” which notes that some industry experts believe smart beta might reach $6 trillion within the next few years (Marriage [2013]). They also identified experts who believe smart beta is a fad, with investors simply following a “label because it is fashionable.” “Smart Beta Bandwagon Gathers Pace,” a follow-up article by Financial Times a few months later, on April 29, 2014, references a Russell Investment survey that indicated as of that time, 32% of the 131 largest pension funds, endowments, and foun- dations had invested in smart beta. Whether smart beta is a f leeting fad or long-term industry trend is not yet clear, although the holdings continue to rise. 2 For example, Jacobs and Levy [2014] noted that the decision not to hold the capitalization-weighted market portfolio is an active decision in itself. Furthermore, they maintained that smart beta strategies require additional active decisions made at the outset, such as specific factor(s) to target, weighting method, and so on. 3 InvestmentexpertWarrenBuffett(amongothers)expends considerable energy in assessing the quality of management. ENDNOTES
He places great importance on the company management’s concerns for shareholders and seeks behaviors that align with stakeholder interests. Despite the popularity of a company management focus among active fund managers, few pas- sive ETFs focus on management criteria, and it appears even fewer, if any, address smart beta solutions. Solactiv and Entre- preneurShares are two firms that have a management-based, or founder-CEO, index. Global X has issued a founder-CEO ETF, and EntrepreneurShares has a series of entrepreneur mutual funds, separately managed accounts (SMAs), and ETFs. BlackRock (iShares), one of the market leaders in smart beta methodologies, has 43 smart beta strategies with approxi- mately $70 billion in assets under management (AUM) but, to date, no management-based ETF. 4 Leadership matters, or at least theoretically should matter. Logic aside, the notion that quality leadership traits can be appropriately measured and correctly valued for the proper time period may be a separate issue. We recognize that CEOs may not always receive the credit (or blame) for the company performance that is reported during their stay in office. Problems or solutions generated by a predecessor or changing market conditions beyond the control of the CEO often result in performance that is also beyond the control of the CEO. Moreover, the short duration of most CEOs of publicly traded companies (3–5 years) suggests that this exer- cise (allocating blame or credit) for performance while in office may be moot. We note that founder CEOs, unlike professional CEOs who are not the creator of the company, have (traditionally) a much longer duration in their position (7–10 years). The length of time differential for a founder CEO (compared to a professional CEO) is about double the norm. Moreover, we will later provide some evidence of market-adjusted returns before and after the founder CEO spends time in office. In short, we attempt to stake the argu- ment that 1) proper leadership matters and 2) founder CEOs may provide evidence of good leadership. 5 Fama and French [1993] created a framework to address factor-based smart beta strategies. In their article, they were able to demonstrate how certain factors, such as market capitalization and book to market equity, enabled investors to generate returns higher than predicted by the capital asset pricing model. They proposed a three-factor model that sug- gested market, size, and value help to explain much of the returns for a portfolio. Later, Fama and French expanded their three-factor model to a five-factor model that also included earnings and investment (increase in book equity). Carhart [1997] attempted to improve upon the Fama–French three-factor model by adding a momentum factor (creating a four-factor model). In this article, we explore the Fama– French factors as well as the incremental momentum factor by Carhart. For completeness, we also add at least 20 other factors provided by Bloomberg to examine potential factor
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