Scientific Beta

The latest Scientific Beta special issue of the EDHEC Research Insights supplement to Investment & Pensions Europe examines a wide array of topics including why investors should stick with their factor strategies in crises; the existence of crowding risk; the importance of robustness; the use of an intangible-adjusted value factor; the benefits of Scientific Beta's high-factor-intensity filter; regulatory issues pertaining to climate indices and sustainability disclosures, the use of enterprise value for normalisation, and Scope 3 emissions; ESG engagement vs. divestment; the Core ESG filter offered by Scientific Beta; and Scientific Beta's new dynamic defensive solution and Historical Volatility Adjustment risk control option that enable investors to remain defensive during episodes of severe market stress.

The latest issue of the EDHEC Research Insights supplement to Investment & Pensions Europe is a Scientific Beta special edition.

We first discuss 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 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 with 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 given the objectives of a strategy or not.

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.

We present a critical appraisal of recent EU regulatory developments pertaining to climate indices and sustainability disclosures for passive investment. We feel that investors should identify the extent to which portfolio construction takes into consideration key transition sectors’ decarbonisation pathways and/or corporate-level evidence of commitment to or alignment with the Paris Agreement.

The European Benchmark Regulation has recently mandated the use of enterprise value for normalisation. Partial recognition of data issues and biases plaguing enterprise value led the regulator to reintegrate cash in its definition and adopt an alternative metric for private companies – the latter introducing consistency and transparency issues across benchmarks. Reliance on volatile valuation data dramatically reduces the association between changes in measured intensity and underlying emissions. Reliance on revenues is preferable if reductions in emissions and gains in process efficiency are to be encouraged.

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 it being 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.