Smart Beta 2.0
Noël Amenc, Felix Goltz, Lionel Martellini: Recent years have seen increasing interest in new forms of indexation, referred to as Smart Beta strategies. Investors are attracted by the performance of these indices compared to traditional capweighted indices.
Professor of Finance, EDHEC Business SchoolDirector, EDHEC-Risk Institute
Head of Applied Research, EDHEC-Risk InstituteLionel MartelliniProfessor of Finance, EDHEC Business SchoolScientific Director, EDHEC-Risk Institute
However, by departing from cap-weighting, Smart Beta equity indices introduce new risk factors for investors, and no sufficient attention is presently given to the evaluation of these risks. In addition, the Smart Beta market appears to be inefficient today, due to restricted access to information, as well as lack of independent analysis.
This paper puts forth a new approach to Smart Beta Investment, called the Smart Beta 2.0 approach.
In fact, a first important step towards a better understanding of Smart Beta strategies is to conduct proper analysis of risk and performance of Smart Beta strategies rather than relying on demonstrations of outperformance typically conducted by the providers of the strategies.
Secondly, Smart Beta 2.0 allows investors to not only assess, but also to control the risk of their investment in Smart Beta equity indices. Rather than only proposing pre-packaged choices of alternative equity betas, the Smart Beta 2.0 approach allows investors to explore different Smart Beta index construction methods in order to construct a benchmark that corresponds to their own choice of risks. In particular, we discuss the following types of risk: i) exposure to systematic risk factors (which can be managed through stock selection decisions or factor constraints); ii) exposure to strategy specific risk (which can be managed by diversifying across strategies); and iii) relative performance risk with respect to traditional market cap-weighted benchmarks (which can be managed through tracking error control).
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