Scientific Beta

The latest issue of the EDHEC Research Insights supplement to Investment & Pensions Europe is a Scientific Beta special aiming to bring scientific clarity to many questions that are too often approached in an anecdotal way and in any event without real and serious empirical evidence. Articles look at the price effects of rebalancing trades on factor indices, the recent poor performance of factor indices and the continued place of the size factor in multi-factor portfolios. The supplement also presents the different elements of Scientific Beta's index offering.

The latest issue of the EDHEC Research Insights supplement to Investment & Pensions Europe aims to bring scientific clarity to many questions that are too often approached in an anecdotal way and in any event without real and serious empirical evidence. As such, we first investigate whether the performance of factor indices suffers from stock prices’ reactions to rebalancing trades and find that, unlike for cap-weighted indices, there has been no significant price effect. We argue that index providers should offer information to investors on the price effects generated by their indices.

There has also been much talk about the recent poor performance of long-only multi-factor strategies, with some commentators saying that factor strategies are perhaps no longer a useful investment tool. We argue that it is in fact poor diversification of other exposures, namely to unrewarded risks, that is behind the disappointing numbers, rather than the performance of the factors themselves.

Finally, we examine whether the size factor still has its place in multi-factor portfolios. The academic literature sees the size factor as an important driver of return differences across equity portfolios. In fact, removing the size factor deteriorates explanatory power more than removing any of the other standard factors does.

Scientific Beta offers investors single smart-factor indices as long-only or long/short indices. The indices are constructed consistently and seek robustness at all stages of the construction process. We describe these indices and explain how institutional investors can use them as part of a portfolio completeness approach.

We look at designing more defensive solutions for investors. When constructing a defensive portfolio, the factor-investing approach is more robust than popular optimisation techniques. It delivers a similar level of protection in distressed times but also typically exhibits better Sharpe ratios and conditionality.

As alluded to above, despite their positive long-term premium, equity factors experience periods of substantial underperformance. Macroeconomic conditions influence this factor cyclicality. We propose a methodology for analysing the macroeconomic risk of equity factors, and show that ignoring such risks may lead to under-diversification of multi-factor portfolios.

Smart factor indices offer exposure to risk factors that are well rewarded over the long term. There is strong empirical evidence and economic rationale for this. In addition to capturing exposure to factors, the indices ensure a good reward for these exposures through diversification of unrewarded (specific) risk. Diversification improves long-term risk-adjusted performance while reducing short- and medium-term risk.

We present Scientific Beta’s new low carbon fiduciary option, which is applicable across our entire flagship offering of multi-factor indices. It addresses the three most common decarbonisation objectives for investors: contributing to the transition to a low-carbon economy, reducing the ‘carbon footprint’ of investments and reducing exposure to climate change risks.

Scientific Beta is also introducing an ESG fiduciary option that is applicable across its entire flagship offering. This option is relevant to investors who wish to dissociate from controversial companies, demonstrate support of global norms, mitigate reputational and liability risks or avoid ESG risks with potential adverse financial materiality. These benefits are delivered while retaining the financial outperformance of the standard flagship indices.

Furthermore, Scientific Beta offers enhanced ESG reporting on all its indices on a complimentary basis to assist investors in ESG incorporation. The ESG Norms analytics measure index exposure to companies whose conduct violates fundamental ethical or corporate governance norms or with involvement in products that conflict with global ESG norms or their objectives. The climate change analytics support assessments of investments’ indirect contributions to climate change, assessment of exposure to companies and sectors with high potential to climate transition risks, and assessment of exposure to physical risks.