Scientific Beta

Sophisticated institutional investors have increasingly started to review factor-based equity investment strategies. This article, published in the July/August 2014 issue of the Journal of Indexes, provides practical illustrations of multifactor allocations drawing on smart-factor indexes, representing a set of four well-documented and popular risk factors: value; momentum; low volatility; and size.

While in practice, investors may select among various ways of combining smart-factor indexes in order to account for their investment beliefs, objectives and constraints, the cases of an equal-weighted allocation, and a (relative) equal-risk contribution allocation to four smart-factor indexes seeking exposure to the main consensual factors (notably value, momentum, low volatility and size) provide evidence that the benefits of multifactor allocations are sizable. In particular, exposure to various factors whose premia behave differently over time and across market conditions provides for smoother outperformance. Moreover, natural crossing benefits reduce turnover of multifactor mandates relative to separate single-factor mandates. Investors and asset managers may thus be well advised to further explore the potential of multifactor allocations in a variety of investment contexts.