Without careful robustness verifications, 1 in 20 portfolio simulations would accidentally look attractive. Factordriven approaches have become so popular that even theorybased pricing models now take factors into account when evaluating investments. The research, led by antti suhonen, a finance professor at aalto university in finland, and published in may, warned of problems with the robustness of smart beta strategies after finding. Adding to the confusion is that, similar to alternative investing, smartbeta mandates do not fit neatly into a homogeneous category. Smart beta funds stalked by chaotic factor zoo financial. Concerning actual investment decisions, a relevant question is. With already around usd12bn of aum in smart beta solutions in both active and. The anatomy of smart beta smart beta indexes have become increasingly popular in recent years, with nearly threequarters of global institutional investors and asset owners now either using or evaluating smart beta index based strategies for their portfolios. The ftse russells 2017 smart beta investor survey highlighted that the most important objective for allocating to smart beta strategies was risk reduction, followed by return enhancement. Smart beta strategies are designed to add value by systematically selecting, weighting, and rebalancing portfolio holdings on the basis of factors or characteristics other than market capitalization ra, 2017.
These are usually based on either a single factor e. The site has over 15,500 members, who between them download more than 12,000 white papers every month. Many investors believe 10 years is long enough to assess a strategys ability to deliver future performance. First, a factor should be grounded in a long and deep academic literature. Smart beta or factor tilt investing strategies are subject to all the risks common to equity investing such as loss of capital. Academic consensus is key to robust smart beta strategies new publication from eri scientific beta examines the robustness of smart beta strategies.
As smart beta assets continue to grow, jacobs 2015 suggests that a dynamic. Poor timing of an initial investment in certain factors. One of the fastest growing segments of etf market that has been attracting a lot of attention in recent. Smart beta, alternative beta, exotic beta, risk factor, style. The winning research paper, robustness of smart beta strategies. A strategy is assumed to be robust if it is able to deliver similar outperformance in similar market conditions. Cogent researchnow market strategies international 2014 across the world have confirmed the growing interest in exploring smart beta strategies. Another attraction of smart beta strategies, we believe, is their solid economic rationale. Robustness of smart beta strategies the journal of index. Bloomberg calculation by ossiam in usd from january 2004 to august 2018 2 is the return of the smart beta strategy the benchmark, 3 is the return of cash. Pdf redefining indexing using smart beta strategies. Examples include fundamentallyweighted indices and minimumvolatility indices. Our results lend support to the cautions in recent literature regarding backtest overfitting and lack of robustness in trading strategy performance during the. How smart beta is disrupting the investment management industry.
Strategic beta strategies are designed to provide market exposure based on nonpriceweighted fundamentals. The assets invested in smart beta strategies have grown at a breathtaking pace,1 as have the variety of smart beta products and the number of allegedly premiumbearing factors underlying smart beta indexes. The magnitude of the flows into smart beta portfolios also ignores the diversity of smart beta approaches available to investors, which can result in a variety of different exposures, even within similarsounding strategies. Apr 11, 2019 smart beta strategies may use alternative weighting schemes such as volatility, liquidity, quality, value, size and momentum. A framework for assessing factors and implementing smart beta.
Pension funds, endowments, insurance companies and. Besides return premia, smart beta strategies in asia show similar characteristics as the same strategies in the us. Smart beta strategies use alternativelyconstructed indices to take advantage of market inefficiencies and underlying risk factors. Pdf over the past several years, a number of new strategies and solutions have been launched in the. Smart beta strategies have been criticised for increased liquidity risks and some have asserted that their outperformance is due to capturing an illiquidity premium. Whereas we focus on one of the most commonly accepted robust factorsvalue, as represented by the fundamental index approachthe underlying lessons and considerations drawn from this example are broadly applicable to. Smart beta strategies may also be implemented in some quantitatively managed mutual funds, hedge funds, and. We look at relative erc and relative gmv allocations invested in the 20 diversified multistrategy indices with stock selection based on midcap, momentum, low volatility, and value in the five us, uk, developed europe exuk, japan and asia pacific exjapan subregions. Pdf why your smart beta portfolio might not work researchgate. Factor robustness our colleagues recently proposed a framework for how to determine which of roughly 300 factor strategies are robust beck et al. Standard benchmark indices weight their constituents by market capitalization, or size, and can act as a proxy for broad. A value factor index would be deemed robust if it aligns well with the.
To address this challenge, we believe investors should be aware of the elements that constitute quality craftsmanship in the design of smart beta strategies, and make their product selection decisions accordingly. To address this challenge, we believe investors should be aware of the elements that constitute quality craftsmanship in the design of smart beta strategies, and. Some strategies might define momentum to be the 11month stock return lagged one month. Lets compare the excess returns of the six factortilt strategies and the six smart beta strategies. Many smart beta strategies are constructed with an emphasis on simplicity, often using simple sorting and weighting techniques. Using smart beta to outsmart the market institutional investor. Smart beta strategies may use alternative weighting schemes such as volatility, liquidity, quality, value, size and momentum. According to scientific beta, their publication highlights the importance of a limited choice of factors with simple definitions to avoid the temptations of factor mining or factor fishing, which are among the main causes of the lack of relative outofsample robustness of smart beta strategies that are based on factor exposures. Another concern with smart beta indices is that they are often based on backtests which only go back ten or fifteen years in time. A framework for assessing factors and implementing smart. Even taxes should be considered in the strategy vadlamudi and bouchey 2014. However, given that smartbeta etfs are effectively longonly products with slight factor tilts, diversification benefits and an associated risk reduction. The table compares the performance and risk of scientific beta diversified multistrategy indices converted into us dollars. Smart beta products are a disruptive financial innovation with the potential to significantly affect the business of.
We investigate the biases in the backtested performance of alternative beta strategies using a sample of 215 commercially promoted trading strategies across five asset classes. Often referred to as smart beta or alternative beta, these strategies offer the potential for attractive riskadjusted returns and can be. Scientific beta develops framework for assessing smart. Given smart betas popularity among investors and asset managers, people ask me about this strategy also known as alternative beta, exotic beta, risk factor, style premia, risk premia investing all the time. Cogent researchnow market strategies international 2014 across the world have confirmed the growing interest in exploring smartbeta strategies. We find that all smart beta strategies outperform these benchmarks from year 2006 to year 2015, and that all smart beta strategies outperform the sse 50 index by an average of 2. For strategies with a beta below 1, therefore relatively less risky, the beta effect is a drag. We look at the latest 10 years 2005 q32015 q3 and almost 49 years 19672015 q3. We then look at the alpha of the minimum variance strategies in europe, the uk, japan, emerging market and world.
The choice of which factor or factors to tilt toward or away from can result in strategies that either beat or lag the market. Robustness of smart beta strategies semantic scholar. The choice of which factor or factors to tilt toward or away from can result. First and foremost, we are eager to do away with the positive connotations inferred by the smart in smart beta. Quantifying backtest overfitting in alternative beta. A smart beta etf is a type of exchangetraded fund that uses alternative index construction rules instead of the typical capweighted index strategy, in a. The term strategic is meant to draw attention to the fact that the benchmark indexes underlying the etps, mutual funds. Robustness of smart beta strategies wins best smart beta paper. What really explains the poor performance of factor strategies.
In my mind there are only a couple of truly smart beta strategies and these are optimised smart beta strategies. A survey published in january 2015 by market strategies international found that 64% of institutional decision makers expected to increase their use of smart beta etps within 12 months1. Building confidence in smart beta equity strategies. To capture yield and mitigate risk, investors have embraced smart beta strategies. The efficacy of factorbased investing can be explained by the continued existence of significant market frictions and the wellknown behavioral limitations of investors. Although there is no consensus on whether smart beta strategies should be considered as passive or active management, we can all agree that they follow a systematic and rulesbased process. Whereas we focus on one of the most commonly accepted robust factorsvalue, as represented by the fundamental index approachthe underlying lessons and considerations drawn from this example are broadly applicable to all smart beta strategies. An investor new to the smart beta arena can easily be overwhelmed with the immensity of product offerings. Besides product development, it is essential that asset managers offer both education and advice, as the smart beta arena can be confusing. The issue of robustness, as in extreme risk and performance attribution to welldefined risk factors, is not dealt with by index providers despite investors being wary of robustness of outperformance of various smart beta strategies. Strategic beta strategies are designed to provide market exposure based on nonpriceweighted fundamentals or economic factors. Strategies, has won the best smart beta paper award in the savvy investor awards 2016. In the context of smart beta strategies, two kinds of robustness need to be taken into account relative robustness and absolute robustness.
These are really aimed at optimising the strategy rather than just performing differently to market cap weighting. Understanding smart beta smart beta has become one of the most popular concepts in modern finance. Advanced beta strategies play an important role in helping investors to. When adopting smart beta strategies, investors should consider which set of factor exposures is best aligned with the investment goals and beliefs marchioni et al. One must invest in a mutual fund or exchangetraded fund that closely tracks the index. The process is designed to deliver an efficient replication of smart beta indices with a constant focus on minimising costs and monitoring turnover and liquidity. Often referred to as smart beta or alternative beta, these strategies offer. Also known more recently as strategic beta and alternative beta, the concept is far from new and has been around for decades as investors have used alternative weighting and factors to manage portfolio risk and return. To limit this risk and further assess the robustness of a smart beta strategy, it is recommended to analyse it on a variety of universes e. Jul 05, 2015 a framework for assessing factors and implementing smart beta strategies by institutional investor journals.
Ten misconceptions about smart beta edhecrisk institute. We have shown that, while naively implemented smart beta strategies may obviously suffer from much reduced liquidity, the outperformance of smart beta strategies. Robustness study for value in treasuries the results depend on 3 parameters. Adding to the confusion is that, similar to alternative investing, smart beta mandates do not fit neatly into a homogeneous category.
They are also subject to risks that are unique to smart beta investing. Methodologies used in the interactive smart beta tool research. When the valuation ratio of a strategy or factor is at its historical average, this. Request pdf on may 11, 2015, jason hsu and others published a framework for assessing factors and implementing smart beta strategies find, read and cite all the research you need on researchgate. This can be structured as either an etf or an index fundmandate. Smart beta strategies financial data and calculation factory. Rulesbased and transparent, they reweight traditional capweighted indexes by a variety of specific factor. I feel the term smart is misleading as these strategies are often rather very simple and only made smart by their outperformance of market cap weighting.
On the one hand, smart beta strategies provide an alternative weighting scheme for stocks, i. The robust equities market has ramped up disproportionately to economic growth. In addition, smart beta strategies can be inefficient from a turnover perspective, or can have unattractive exposures to factor premiums other than the one that is primarily targeted. Smart beta strategies can be used in their portfolios. Robustness of smart beta strategies the journal of index investing. Smart beta, alternative beta, exotic beta, risk factor. Investors increasingly embrace smart beta investing, by which we mean passively following an index in which stock weights are not proportional to their market capitalizations, but based on some alternative weighting scheme.