Scientific Beta

The Scientific Beta white paper, "What Really Explains the Poor Performance of Factor Strategies over the Last 3 Years?" was highly commended in the "Factor Investing" category of the Savvy Investor Awards 2019 that celebrate the world’s best investment content and thought leadership. Scientific Beta's publication shows that recent underperformance is not the result of a deterioration in factor performance, since it has been possible to offset negative performance for some factors through the good performance of other factors, but relates more to the implementation choices of the factor exposures than to the factors.

The Scientific Beta white paper, "What Really Explains the Poor Performance of Factor Strategies over the Last 3 Years?" published in September 2019, was highly commended in the "Factor Investing" category of the Savvy Investor Awards 2019 that celebrate the world’s best investment content and thought leadership. The results were judged across 15 categories, with the judges starting from a "short-list" of over 500 papers, which were assessed based on their quality, readability and appeal to Savvy Investor's institutional investor audience.

Scientific Beta's publication shows that recent underperformance is not the result of a deterioration in factor performance, since it has been possible to offset negative performance for some factors through the good performance of other factors, but relates more to the implementation choices of the factor exposures than to the factors.

Indeed, contrary to what has been affirmed without any really serious study or even rigorous empirical observations, the poor performances of multi-factor indices or solutions are not the result of a strong and abnormal deterioration in factor performances. One can certainly observe that some factors have experienced significant underperformance, but it has been possible to offset this with the performances of other factors. Ultimately, the average risk premium of the consensual six long/short market-neutral factors remains positive.

The main explanation for the underperformance of long-only factor indices and solutions relates more to the implementation choices of the factor exposures than to the factors themselves. In a long-only framework, index and strategy design rarely takes account of the non-factor risks induced by the factor exposure choices. Among these risks, as we have documented in many research publications, the market beta risk or gap, which often corresponds to an unstable and defensive bias in the construction of factor strategies, is the one that has the most impact over the long term in terms of both the return and volatility of these strategies.

In the last 3 years, the non-control of market beta exposure in a bull market context has prevented factor indices from benefitting fully from the important market risk premium. It is this poor market conditionality rather than the variations in factor returns that explains the disappointing performance of long-only factor offerings over the past 3 years.