Scientific Beta

This EDHEC-Risk Days Special issue of the Research Insights supplement in partnership with Investment & Pensions Europe (IPE) presents several key research results in the field of smart beta, looking at diversified vs concentrated factor tilts, common misconceptions about smart beta performance drivers, the results of the latest EDHEC European ETF survey, and smart betas in ALM. 

This supplement is an EDHEC-Risk Days Special that ties in with the flagship conference presented by EDHEC-Risk Institute in March 2016. Several of the articles present key research results in the field of smart beta.

In a first article, we compare different approaches to the design of factor indices in the equity space, notably concentrated indices and more diversified indices. We analyse broader and more narrow stock selections, as well as two different weighting schemes – equal-weighting and cap-weighting. Overall, it appears that concentrated factor tilts lead to implementation challenges that are not compensated by better risk-adjusted returns. Using a more diversified weighting scheme such as equal-weighting, however, leads to significant improvements in performance with manageable implementation properties.

We then provide perspective on misconceptions about performance drivers by drawing on conceptual considerations and empirical evidence. The analysis shows that, more often than not, superficially convincing claims about smart beta performance drivers stand on shaky foundations. Our analysis also shows that considering a breadth of evidence and conceptual considerations may perhaps lead to more balanced conclusions and a more nuanced understanding of smart beta performance.

A further article sums up the results of the most recent EDHEC European ETF Survey, which was conducted at the end of 2015 with the support of Amundi ETF & Indexing. The survey shows stable high-level satisfaction with products and increasing appetite to rely on ETFs for ever more aspects of portfolio management. Moreover, we observe recent increased interest in ETFs that track smart beta indices. When it comes to smart beta ETFs, however, investment professionals also have strong quality requirements for the underlying indices, most notably in terms of transparency.

Finally, we look at whether it would it make sense for a pension fund to hold a customised equity portfolio engineered to exhibit enhanced liability-hedging properties versus holding a broad off-the-shelf equity index. We conclude that investors with liability constraints will strongly benefit from switching their equity portfolio from a cap-weighted benchmark to a dedicated liability-friendly portfolio based on the selection of stocks which combine low volatility and high dividend yields and a constrained minimum-variance optimisation.