Scientific Beta

Pensions Expert: "With pension funds increasingly embracing risk factor investing, it is essential to ensure a factor premium is supported by empirical analysis, economic rationale and a simple factor definition."

Pensions Expert 31/10/2016

Article by Felix Goltz, research director, ERI Scientific Beta

"(...) With pension funds increasingly embracing risk factor investing, it is essential to ensure a factor premium is supported by empirical analysis, economic rationale and a simple factor definition. (...) It is daunting to conduct empirical analysis to establish which risk factors carry a reward. Researchers struggle to estimate expected returns, simply because they rely on very few data points: the starting price level and the end date price level. This is also true for factor returns. As such, when testing whether a factor carries a premium, academic research conducts a thorough assessment, including the analysis of very long-term data across different regions and asset classes, and includes various corrections for possible data mining biases. These studies are open to criticism and numerous papers are written to question previous empirical results. Consequently, academic research is much more capable of providing meaningful conclusions than a simple product backtest for a given factor index product. (...)"