Scientific Beta

The latest issue of the Pensions & Investments/EDHEC-Risk Institute Research for Institutional Money Management supplement looks at the multi smart factor approach, the robustness of the outperformance of smart beta equity strategies and the long-term performance of ERI Scientific Beta indices.

Given that there is so much choice in the area of alternative forms of equity indices, a natural question that arises for investors is which index to select. A good smart beta index is one that diversifies away the specific risks and manages the exposure to equity risk factors. Our first article on the subject of smart beta, "Smart Beta 2.0: A Powerful Concept for Multi Smart Factor Investing", shows how to construct smart (well-diversified) factor indices and the benefits gained from diversifying across them – the multi smart factor approach.

In a further article entitled, "How Robust is the Outperformance of Smart Beta Equity Strategies?", we examine the performance of smart beta equity indices using long-term (40-year) data. Most smart beta indices are marketed on the basis of outperformance, but usually their back-tests are conducted over a limited time period. Critics of smart beta often question the robustness of these strategies over the long term, but in our long-term analysis all diversification strategies deliver higher returns than the cap-weighted reference index, with annualized outperformance of more than 2.3%. Moreover, all of the diversification strategy indices exhibit better risk-adjusted performance.

Finally, in an article entitled "Long-Term Performance of Scientific Beta Indexes", we examine the robustness of the outperformance of smart beta (alternative-weighted) equity strategies. Assuming that certain market conditions may influence the capacity of a given weighting scheme to provide outperformance over cap-weighted reference indices, it is crucial for investors to assess the risk of underperformance as well as the conditional performance profile of any smart beta strategy so as to gain a better picture of the robustness of the potential outperformance of a strategy.