Scientific Beta

etfexpress: "As investor interest in smart beta gathers steam, this etfexpress report separates the hype from reality and outlines the risks and opportunities of smart beta investments".

etfexpress 13/05/2013

Special Report: Smart Beta 2013 

• The Smart Beta 2.0 approach
  
  Article by Noël Amenc, CEO of ERI Scientific Beta, Director of EDHEC-Risk Institute, Professor of Finance at EDHEC Business School
  
  "(...) Interest in new forms of indexation, referred to as smart beta strategies, has grown in recent years. Investors are attracted by the performance of these indices compared to traditional cap-weighted indices. However, by departing from cap-weighting, smart beta equity indices introduce new risk factors for investors, and sufficient attention is not presently given to the evaluation of these risks. In addition, the smart beta market appears to be inefficient today, due to restricted access to information, as well as lack of independent analysis. EDHEC-Risk Institute recently put forth a new approach to smart beta investment, called the “Smart Beta 2.0” approach. A first important step towards a better understanding of smart beta strategies is to conduct proper analysis of risk and performance of smart beta strategies rather than relying on demonstrations of outperformance typically conducted by the providers of the strategies. Secondly, Smart Beta 2.0 allows investors not only to assess, but also to control the risk of their investment in smart beta equity indices. Rather than only proposing pre-packaged choices of alternative equity betas, the Smart Beta 2.0 approach allows investors to explore different smart beta index construction methods in order to construct a benchmark that corresponds to their own choice of risks. (...)
  
  
• The risks and opportunities of smart beta investments
  
  "(...) Greater transparency is something that EDHEC-Risk Institute is calling for improvements on, arguing that too many smart beta products are pre-packaged and sold to investors who have no idea what risks are being taken or how alternatively weighted indices are being constructed. “Investors don’t have enough controls over the risk parameters being used in smart betas. The risk exposures are already chosen for investors to a certain extent. Our viewpoint is that they should be allowed to make those choices themselves. They should choose which risks they want to be exposed to, and which ones they don’t,” says Peter O’ Kelly, ERI Scientific Beta’s Director of Marketing. (...) EDHEC-Risk refers to this investor-centric approach to managing risk and having access to better transparency as “Smart Beta 2.0”. The authors behind this study, Noël Amenc, Felix Goltz and Lionel Martellini show that Smart Beta 1.0 indices present systematic and specific risks that are neither documented nor explicitly controlled by their promoters. They argue that specific risk, which is often characterised as model and parameter estimation risk, can be both measured and managed. Being able to better diversify the specific risk of smart beta products significantly lowers the specific risk of smart beta benchmarks says the authors. “We’re in favour of investors having the ability to do research effectively on a smart beta product and be in control of the risks before they allocate. They should be deciding what’s in the product, rather than being presented with it,” says O’ Kelly. (...)"

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