Scientific Beta

An article published in the inaugural issue of the EDHEC-Risk Institute supplement to AsianInvestor argues that investors in alternative equity index strategies should evaluate and control risk factor exposures by disentangling the effects of stock selection and stock weighting. A second article looks at how to measure and manage the specific risks of smart-beta investing, using the framework of Modern Portfolio Theory to obtain an optimal answer to the question.

In an article entitled "Smart-beta indices: selecting risk exposures" (pages 14-17), we argue that investors in alternative equity index strategies should evaluate and control risk factor exposures by disentangling the effects of stock selection and stock weighting. Advanced beta weighting schemes can induce implicit factor tilts, but it is possible to correct them without completely sacrificing the benefits of such schemes. Investors can choose their desired type and level of risk factor exposure by separating stock selection from the weighting scheme.

A second article on "Measuring and managing the risks of smart-beta investing" (pages 18-20), looks at how to measure and manage the specific risks of smart-beta investing, using the framework of Modern Portfolio Theory to obtain an optimal answer to the question. We conclude that the benefits of diversifying away the specific risks of smart-beta benchmarks can be substantial.