Scientific Beta

A special guide to factor investing published by IPE, with several articles citing ERI Scientific Beta and its research: "Portfolio Construction: Calculated risks", "Index Providers: Benchmark bonanza", "Factor investing: Pension funds in two minds", and "The French quant connection".

IPE April 2016

Portfolio Construction: Calculated risks
"(...) The idea behind factor investing is simple yet persuasive. To the extent that rewarded and unrewarded risks in financial markets can be successfully distinguished, investors should minimise portfolio exposure to unrewarded ones. This, in turn, should enhance long-term returns. Felix Goltz, head of applied research at EDHEC-Risk Institute emphasises the importance of the distinction between the two types of risk – rewarded and unrewarded. He explains: “There are some risks that are not easy to diversify away from. By taking exposure to these risks, a portfolio may experience losses at certain times, but the investor is rewarded for that exposure in the long term.” (...) But what are examples of risks that are not rewarded systematically in financial markets? The best example is stock-specific risk, according to Goltz, as it can be cancelled out by not investing in that stock. Because of that possibility to diversify away that risk, investors should not assume they will be rewarded for holding it. (...)"

Factor investing: Pension funds in two minds
"(...) “Compared with active managers, factor investing is more rules-based and transparent than active management, hence significantly more cost-effective,” says Eric Shirbini, global product specialist at ERI-Scientific Beta. “Yet it delivers around 85% to 90% of the outperformance of active managers. It also means you don’t have to try and find the best active managers, especially that rarity who outperforms the market.” He adds that, while asset managers’ fees are all-inclusive, so hard to break down, investors know how much they are being charged for the factor index itself (that is, the intellectual property) and, separately, the trading costs. This, he says, will put downward pressure on costs. (...) Shirbini says pension funds are using factor investing to replace underperforming active managers when their mandate expires. “When they do that, it’s important not to invest in a single factor, because losses will hit you at some point in the cycle,” he says. “So they invest in a portfolio of factors, using a multi-factor index.” He adds that another popular route is to use low-volatility factors in defensive strategies, investing in stocks such as utilities and consumer defensive stocks. (...)"

Index Providers: Benchmark bonanza
"(...) Research is also at the heart of EDHEC-Risk Institute which, three years ago, caused a stir with its paper, Smart Beta 2.0, that criticised the first generation of products for presenting systematic and specific risks that were neither documented nor explicitly controlled by their promoters. To rectify the problem, EDHEC-Risk recommended that the choice of systematic risk factors for smart beta benchmarks should be explicit, and made by the investor, not the index promoter, according to Felix Goltz, director of research at ERI Scientific Beta and one of the authors of the paper. EDHEC-Risk, which has about $8bn (€7.4bn) tracking its strategies, launched the Scientific Beta Developed Multi-Beta Multi-Strategy index which blends four stock-selection factors (volatility, valuation, size and momentum) with five smart beta diversification strategies. These comprise an equal, as well as an efficient volatility weighting, plus a diversified multi-strategy approach that allocates stock weighting based on the average of these five separate methodologies. (...)"inde

The French quant connection
"(...) Noël Amenc, director of ERI Scientific Beta, the commercial spin-off of EDHEC Business School, says the reason for French asset managers’ recent focus on quantitative equity strategies is because it is a natural way for them to compete using mathematical prowess in tough markets. “France does not have a deep pension sector. As a people, we prefer fixed income to equities because we are risk-averse. Then there is not a deep pot of equities to manage and there is no culture of equity stockpicking in France.” Stockpicking, with all the attendant research, is expensive and Amenc observes that the Americans have a long history of doing it well. “But smart beta is cheap.” So here he sees an entry-point for the French. (...)"