Is Smart Beta just Monkey Business? An Analysis of Factor Exposures, Upside-Down Strategies and Rebalancing Effects

Noël Amenc, Felix Goltz, Ashish Lodh: “Monkey portfolio” proponents argue that all smart beta strategies generate positive value and small-cap exposure, which fully explains their outperformance.

Author(s):

Noel Amenc

Professor of Finance, EDHEC-Risk Institute,CEO, ERI Scientific Beta

Felix Goltz

Head of Applied Research, EDHEC-Risk Institute,Research Director, ERI Scientific Beta

Ashish Lodh

Deputy Research Director, ERI Scientific Beta

They also claim that similar results are obtained by any random portfolio strategy, including the inverse of such strategies. We analyse these claims using test portfolios which follow commonly-employed methodologies for explicit factor-tilted indices. Our results directly invalidate all of these claims. In particular, our results show that, while some strategies, such as fundamental equity indexation, may perhaps be mostly driven by a value tilt and may generate similar performance to their upsidedown counterpart, many smart beta strategies display exposure to additional factors, as well as pronounced differences in factor exposures across different strategies. Moreover, and perhaps reassuringly, the inverse of these strategies generates lower performance. That our findings directly contradict the monkey portfolio claims can be explained by our set of test portfolios. While the monkey portfolio arguments may hold for the particular smart beta specifications tested by its proponents, they do not hold in general. An important implication of our results is that one should take care to avoid over-generalising from testing particular specifications of smart beta. For the explicit factor-tilted strategies tested here, our results imply that a careful assessment of investment philosophy and index design is indeed relevant as such strategies do not behave like monkey portfolios.

Type: Working paper
Date: le 30/11/2015
Research Cluster : Finance

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