Scientific Beta

The latest "Scientific Beta” special issue of the Research Insights supplement to AsianInvestor examines the following topics: Keeping faith with factor strategies; The crowding effect in smart beta strategies: Does it exist?; How robust are smart beta strategies?; Including intangible assets in the definition of the Value factor; Improving the quality of factor exposure with a high factor intensity filter; How to consider Scope 3 emissions; Engagement and divestment in the ESG space; An ESG investing approach based on consensus and norms; The shortcomings of traditional defensive strategies; Addressing climate change in defensive portfolios; and An historical volatility adjustment risk-control option: What are the benefits?

The latest "Scientific Beta” special issue of the Research Insights supplement to AsianInvestor first discusses the question of why investors should stick with their factor strategies through periods of crisis. The main conclusion is that the importance of diversification across the six consensus risk factors remains intact.

We discuss crowding risk in smart beta strategies and find that assertions that the popularity of smart beta strategies will ultimately cancel out their benefits are not based on solid evidence.

We assess the robustness of a set of competitor and Scientific Beta indices both from an index design point of view and through the lens of our robustness measurement protocol. We have developed a framework to assess robustness according to five different dimensions and assess whether the uncovered risks are acceptable or not given the objectives of a strategy.

Since the value factor proxy does not aim to capture the true value of a stock, including omitted intangible assets in the accounting book value is in line with the risk-based explanation for the value factor. We confirm in our article that an intangible-adjusted value factor adds investment value for multi-factor investors.

Scientific Beta’s indices enable investors to control for cross-sectional factor interaction effects in the stock selection process. We present the high factor intensity filter, an elegant solution to the problem of factor interactions in a ‘top-down’ framework.

Concerning Scope 3 emissions, the indirect emissions in a company’s value chain, they are sparsely reported and typically not fit for the purpose of asset selection, with much of the data based on estimates. We recommend that concerned investors advocate for Scope 3 accounting in their policy and issuer engagements.

It is often argued that an investor who is dissatisfied with a company’s ESG behaviour, and who wishes to remedy the situation, should stay on as a shareholder and engage with it. We show that far from being incompatible with ESG engagement, ESG filtering sends a clear and consistent divestment message that allows an effective engagement policy to be implemented.

We detail the most consensus-based ESG criteria applied by investors, which we have combined into a core ESG filter, and we explain their normative groundings.

Traditional defensive solutions suffer from negative exposures to reward factors other than the low volatility risk factor, as well as concentration and strong exposures to fixed-income risks. More importantly, they can suffer from huge peaks of volatility during market crises. Scientific Beta offers a new dynamic defensive solution that is really low volatility by combining a robust low volatility index and a maximum volatility protection risk-control option.

Traditional defensive strategies also suffer from a weighted average carbon intensity that is higher than that of cap-weighted indices due to important biases towards sectors such as utilities. We present the Scientific Beta low carbon dynamic defensive solution, which simultaneously resolves the shortcomings of traditional defensive strategies and promotes climate change objectives.

Investors who want their factor strategy to remain defensive during episodes of severe market stress would benefit from the application of a volatility-control option. We present the historical volatility adjustment (HVA) risk-control option.