Scientific Beta

The December 2019 issue of the Research for Institutional Money Management supplement to P&I is a "Scientific Beta" special issue that investigates whether the performance of factor indexes suffers from stock prices’ reactions to rebalancing trades, examines whether the Size factor still has its place in multi-factor portfolios, describes Scientific Beta's single long-only and long/short smart-factor indexes, looks at designing more defensive solutions for investors, proposes a methodology for analyzing the macroeconomic risk of equity factors, and presents Scientific Beta’s new low carbon and ESG fiduciary options.

The December 2019 issue of the Research for Institutional Money Management supplement to P&I is a "Scientific Beta" special issue that aims to bring scientific clarity to many questions that are too often approached in an anecdotal way and in any event without real and serious empirical evidence.

As such, we first investigate whether the performance of factor indexes suffers from stock prices’ reactions to rebalancing trades and find that, unlike for cap-weighted indexes, there has been no significant price effect. We argue that index providers should offer information to investors on the price effects generated by their indexes.

We examine whether the Size factor still has its place in multi-factor portfolios. The academic literature sees the Size factor as an important driver of return differences across equity portfolios. In fact, removing the Size factor deteriorates explanatory power more than removing any of the other standard factors does.

Scientific Beta offers investors single smart-factor indexes as long-only or long/short indexes. The indexes, which we describe here, are constructed consistently and seek robustness at all stages of the construction process. 

We look at designing more defensive solutions for investors. When constructing a defensive portfolio, the factor-investing approach is more robust than popular optimization techniques. It delivers a similar level of protection in distressed times but also typically exhibits better Sharpe ratios and conditionality.

As alluded to above, despite their positive long-term premium, equity factors experience periods of substantial underperformance. Macroeconomic conditions influence this factor cyclicality. We propose a methodology for analyzing the macroeconomic risk of equity factors, and show that ignoring such risks may lead to under-diversification of multi-factor portfolios.

Smart factor indexes offer exposure to risk factors that are well-rewarded over the long term. There is strong empirical evidence and economic rationale for this. In addition to capturing exposure to factors, the indexes ensure a good reward for these exposures through diversification of unrewarded (specific) risk. Diversification improves long-term risk-adjusted performance while reducing short- and medium-term risk.

We present Scientific Beta’s new low carbon fiduciary option, which is applicable across our entire flagship offering of multi-factor indexes. It addresses the three most common decarbonization objectives for investors: contributing to the transition to a low-carbon economy, reducing the "carbon footprint" of investments and reducing exposure to climate change risks.

Scientific Beta is also introducing an ESG fiduciary option that is also applicable across its entire flagship offering. This option is relevant to investors who wish to dissociate from controversial companies, demonstrate support of global norms, mitigate reputational and liability risks or avoid ESG risks with potential adverse financial materiality. These benefits are delivered while retaining the financial outperformance of the standard flagship indexes.