Scientific Beta

Investment Week: "They argue that a smarter approach (called Scientific Beta) is to pick different factors that have been shown to produce outperformance over the long term, namely value stocks, or stocks showing strong momentum plus, of course, smaller cap companies. Newer ‘factors’ have also emerged, such as excluding stocks with higher volatility, but the net effect is the same – however you slice and dice a traditional index, by focusing on traditional factors, you end up improving total returns versus the ‘traditional’ index."

Investment Week 14/04/2014

"(...) In the absence of this focused, approach, the best bet is to be properly diversified between different kinds of shares, while also making sure you are not invested in a small number of positively ‘dangerous’ equities. It is this latter, hugely important insight which was the central revelation of the EDHEC event. The academics at this venerable institution have been running a number of alternative stock market indices that look and feel very different from traditionally market cap weighted structures such as the FTSE 100 and the S&P 500. EDHEC’s economists argue that, actually, these mainstream indices have a very concentrated set of risks, because you are, in reality, investing heavily in a certain type of very large company in terms of market cap. They argue that a smarter approach (called Scientific Beta) is to pick different factors that have been shown to produce outperformance over the long term, namely value stocks, or stocks showing strong momentum plus, of course, smaller cap companies. Newer ‘factors’ have also emerged, such as excluding stocks with higher volatility, but the net effect is the same – however you slice and dice a traditional index, by focusing on traditional factors, you end up improving total returns versus the ‘traditional’ index.But there is also a twist or two – different factors work in different phases of the market. The key is not to trust just one factor, but to mix and match each factor over the cycle. One last insight really stands out – that removing a small number of highly undesirable stocks (say between 10% and 20% of total stocks in an index) significantly boosts returns. This last point is worth repeating again – by simply choosing not to invest in a small bit of the market (the most volatile, the least decently valued, the stocks showing terrifically poor momentum) you actually boost total returns immeasurably. In essence, investing is not about what you actually buy, but what you avoid. (...)"