Scientific Beta

Funds Europe: "Academics from EDHEC-Risk Institute explain how the wrong approaches to smart beta could lead to the loss of diversification. Smart beta was initially conceived as a response to two drawbacks of market-cap indices. The first drawback is that such portfolios typically provide limited access to long-term rewarded risk factors such as size or value, among others. The second problem is that they do not efficiently diversify unrewarded risks due to excessive concentration in the largest market-cap stocks."

Funds Europe 14/06/2017

Article by Noël Amenc, CEO, ERI Scientific Beta, professor of finance, EDHEC-Risk Institute; and Felix Goltz, research director, ERI Scientific Beta, and head of applied research at EDHEC-Risk Institute

"(…) Academics from EDHEC-Risk Institute explain how the wrong approaches to smart beta could lead to the loss of diversification. Smart beta was initially conceived as a response to two drawbacks of market-cap indices. The first drawback is that such portfolios typically provide limited access to long-term rewarded risk factors such as size or value, among others. The second problem is that they do not efficiently diversify unrewarded risks due to excessive concentration in the largest market-cap stocks. However, in recent years, the question of diversification has taken a back seat to the question of appropriate factor tilts, which has become the prime concern of smart beta providers. Positive exposure to rewarded factors is obviously a strong and useful contributor to expected returns. However, products that aim to capture explicit risk-factor tilts often neglect adequate diversification. This is a serious issue because diversification has been described as the only ‘free lunch’ in finance. (...)"