Scientific Beta

Benefits and Pensions Monitor: "The risks and shortcomings of the bottom-up approach are shown to be inefficiency, instability and the inability to control factor exposure and non-factor risks, says the ERI Scientific Beta paper, ‘Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control.’"

Benefits and Pensions Monitor 07/04/2017

"(...) The risks and shortcomings of the bottom-up approach are shown to be inefficiency, instability and the inability to control factor exposure and non-factor risks, says the ERI Scientific Beta paper, ‘Accounting for Cross-Factor Interactions in Multifactor Portfolios without Sacrificing Diversification and Risk Control.’ It compares different approaches for constructing multi-factor equity portfolios: bottom-up score-weighting approaches that target high factor intensity and top-down approaches that also consider diversification objectives. Focusing solely on increasing factor intensity leads to inefficiency in capturing factor premia, as exposure to unrewarded risks more than offsets the benefits of increased factor scores. High factor scores in bottom-up approaches also come with high instability in factor exposure and high turnover. The report introduces a new approach that considers cross-factor interactions in top-down portfolios through an adjustment at the stock selection level. This approach leads to higher levels of diversification and produces higher returns per unit of factor intensity, it says. (...)"