Scientific Beta

Sector risk is an implicit bet investors take when investing in Smart Factor indices. Even if it is not a priced risk factor in the cross-section of expected returns, sector risk can nevertheless have a material impact on short-term performance. In this document, we review the sector risk control option offered to investors by Scientific Beta and that has been available on its platform since its launch in 2013. More specifically, we examine the two complementary approaches to manage sector risk, which are stock selection and sector-neutral allocation. We compare long- and short-term risk-adjusted performance, as well as factor exposures of smart factor indices with and without the sector risk control option. We use long-term data, covering several decades to assess its impact.

Sector risk is an implicit bet investors take when investing in Smart Factor indices. Even if it is not a priced risk factor in the cross-section of expected returns, sector risk can nevertheless have a material impact on short-term performance. In this document, we review the sector risk control option offered to investors by Scientific Beta and that has been available on its platform since its launch in 2013. More specifically, we examine the two complementary approaches to manage sector risk, which are stock selection and sector-neutral allocation. We compare long- and short-term risk-adjusted performance, as well as factor exposures of smart factor indices with and without the sector risk control option. We use long-term data, covering several decades to assess its impact. We then illustrate the short-term consequences that sector risk can have on relative performance. Finally, we conclude that the choice of using the sector risk control option is a trade-off. Investors must balance their aversion to short-term risks, generated by sector, against their willingness to harvest factor risk premia in the most efficient way, in order to achieve the highest risk-adjusted performance over the long run.