Smart Beta Made Smart: Synthetic Risk Factors for Institutional and Retail Investors

We construct synthetic, tradable risk factors using optimal combinations of large and liquid mutual funds and ETFs. We find that investors are not able to harvest the unconditional factor risk premia, although the synthetic portfolios of institutional investors outperform those of retail investors. We also propose a methodology to identify market funds. Lastly, we show that (i) daily flows to naive smart beta strategies are more predictable than those to our synthetic strategies, and (ii) our synthetic HML outperforms a naive one based on fund names. Our results have implications for the evaluations of portfolio managers and cross-sectional return anomalies.