Scientific Beta

IPE: "Many investors are seeking to improve the performance of their equity portfolios by capturing exposure to rewarded factors. However, factor-tilted portfolios may expose investors to substantial relative risk – deviations from cap-weighted reference indices which might result in underperformance over any given short time horizon, despite the long-term potential for outperformance provided by the factor tilts."

IPE March 2015

(...) Many investors are seeking to improve the performance of their equity portfolios by capturing exposure to rewarded factors. However, factor-tilted portfolios may expose investors to substantial relative risk – deviations from cap-weighted reference indices which might result in underperformance over any given short time horizon, despite the long-term potential for outperformance provided by the factor tilts. It is often the case that investors maintain the cap-weighted index as a benchmark, which has the merit of macro-consistency and is well-understood by all stakeholders. In this context, a multi-smart-beta solution can be regarded as a reliable cost-efficient substitute for expensive active managers, and the most relevant perspective is not an absolute-return perspective but a relative perspective with respect to the cap-weighted index. In this article, we present two risk-allocation approaches that may be suitable for enhancing performance with limited relative risk. (...)