Scientific Beta

Blitz and Marchesini (2019) question the investability of factor indices and argue that active management is needed to avoid capacity issues. We show that these claims do not hold. Well-designed implementation rules avoid capacity problems that may arise with poorly designed indices. Pre-announcement of index rebalancing trades eases implementation and helps reduce price impact. Gradual rebalancing allows improving investability of factor indices. Active management is not only unnecessary to improve investability; it also creates hidden risks for investors due to a lack of transparency.

A paper by Robeco researchers questions the investability of factor indices (Blitz and Marchesini, 2019). The paper shows that trades to replicate some factor indices would generate more volume than is available on markets. It also argues that transparent rebalancing leads to price distortions. It concludes that there are severe shortcomings to replicating factor indices, and recommends active factor strategies instead. We show that the conclusions in the Blitz-Marchesini paper are erroneous. Well-designed implementation rules avoid capacity problems that may arise with poorly designed indices. Pre-announcement of index rebalancing trades eases implementation and helps reduce price impact. Gradual rebalancing allows improving investability of factor indices. Active management is not only unnecessary to improve investability; it also creates hidden risks for investors due to a lack of transparency.