Leadership Matters: Crafting a Smart Beta Portfolio with a Founder-CEO Twist

Abstract

Smart beta strategies have attracted considerable interest among institutional investors, and it appears this trend has not yet abated. This article suggests an alternative weighting mechanism based on specific management characteristics. In particular, we focus on publicly traded founder-CEO–led companies. Virtually all U.S. large-cap indexes contain at least some founder-CEO–led companies, and recent academic research suggests this variable may be responsible for significant portfolio alpha generation. Our evidence suggests that the founder-CEO factor may be significant not only in building a U.S. large-cap portfolio, it could also very well be one of the most significant factors in explaining excess returns. If true, then a smart beta orientation would be to simply overweight founder-CEO securities within the benchmark index or reduce the allocation to the benchmark index and add an incremental investment in a founder-CEO index. We provide a detailed analysis of a founder-CEO index, spanning several positive and negative economic cycles, and discuss the merits of pursuing this investment strategy. Our evidence suggests that investment managers would be wise to consider this strategy, especially if they can commit to a longer-term investment horizon.

TOPICS: Factor-based models, portfolio construction, performance measurement