After reviewing the methodologies behind more popular quantitative investment strategies offered to investors as passive equity indices, authors devised an integrated evaluation framework. They found that outperform their cap-weighted counterparts largely owing exposure value and size factors. Almost entirely spanned by market, value, factors, any one of these can be mimicked combinations others. Thus, implementation cost is a better criterion than returns.

Value investing, as defined by the Fama–French high book-to-market minus low (HML) factor, has underperformed growth investing since 2007, producing a drawdown of 55% mid-2020. The underperformance led many market observers to argue that value is dead. Our analysis attributes value’s recent two sources: (1) HML book-value-to-price definition fails capture increasingly important intangible assets, and (2) valuations stocks relative have tumbled. Both observations are inconsistent with...

Abstract Factors display strong cross-sectional momentum that subsumes in industries and other portfolio characteristics. The profits of all these strategies—based on factors, industries, characteristics—significantly correlate with each therefore likely emanate from the same source. If factors momentum, so will any set portfolios variation factor loadings. Consistent being at root we find industry-neutral explains industry but none momentum. Cross-sectional concentrates first few...

Factor returns, net of changes in valuation levels, are much lower than recent performance suggests. Value-add can be structural, and thus reliably repeatable, or situational—a product rising valuations—likely neither sustainable nor repeatable. Many investors chasers who pushing prices higher create levels that inflate past performance, reduce potential future amplify the risk mean reversion to historical norms. We foresee reasonable probability a smart beta crash as consequence soaring...

Factor investing has failed to live up its many promises. Its success is compromised by three problems that are often underappreciated investors. First, investors develop exaggerated expectations about factor performance as a result of data mining, crowding, unrealistic trading cost expectations, and other concerns. Second, for using naive risk management tools, returns can experience downside shocks far larger than would be expected. Finally, led believe their portfolio diversified....

Investors play an important role in combating climate change. The authors examine several types of currently available carbon emissions data their capacity to enable investors incentivize companies reduce emissions. evaluate the information content estimated current and forward-looking from four popular providers. Absent mandatory reporting although many report emissions, much are by Despite providers’ claims accuracy, find on (often comprising >50% observations) mostly capture only basic...

Recent index literature is replete with innovations that are based on quantitative strategies and predicated sensible investment beliefs. Empirical studies confirm these deliver economically large statistically significant excess returns over cap-weighted market benchmarks in nearly all regions countries, long periods of time. In this article, the authors show inverting portfolio-construction algorithms does not reverse out-performance. Indeed, upside-down often outperform originals. This...

After reviewing the methodologies behind more popular quantitative investment strategies offered to investors as passive equity indices, authors devised an integrated evaluation framework. They found that outperform their cap-weighted counterparts largely owing exposure value and size factors. Almost entirely spanned by market, value, factors, any one of these can be mimicked combinations others. Thus, implementation cost is a better criterion than returns.

Noah Becka, Jason Hsub, Vitali Kalesnikc & Helge Kostkada Beck is senior researcher in equity research, Research Affiliates, LLC, Newport Beach, California.b Hsu chairman and CEO of Rayliant Global Advisors, Hong Kong.c Kalesnik partner head California. d Kostka CIO Maseco LLP, London.

In our paper — “How Can ‘Smart Beta’ Go Horribly Wrong?” we show that performance chasing can be as dangerous in smart beta it is stock selection, fund or asset allocation. We differentiate between “revaluation alpha” and “structural alpha.” The former the part of past return came from rising valuations. Revaluation alpha nonrecurring, at least likely to reverse persist. Rising valuations create an illusion encourage chasing.

Unlike standard factors, such as value, momentum, and size, "quality" lacks a commonly accepted definition. Practitioners, however, are increasingly gravitating to this style factor. They define quality be various signals or combinations of signals—some that have been thoroughly explored in the academic literature others received limited attention. Among comprehensive group categories used by practitioners, we find profitability, accounting quality, payout/dilution, investment tend...

Classical performance attribution methods do not explicitly assess managers' dynamic allocation skill in the factor domain. The authors propose a generalized framework for that decomposes effect into value added from both static and exposures thus yields additional insight sources of manager alpha.

Past industry returns predict future returns, and this predictability is at its strongest the one-month horizon. We show that cross section of factor shares property momentum stems from momentum. Factor transmits into through variation in industries’ loadings. "systematic industries," mimicking portfolios built factors, subsumes as does industry-neutral factors. Industry therefore a byproduct momentum, not vice versa. Momentum concentrates entirety first few highest-eigenvalue

Twenty years ago there were only five equity factors (market, value, small-cap, momentum, and low beta). Today the literature contains research papers on hundreds of supposed factors, most which will not produce a reliable positive premium in future. Rather than adopting statistical approach, we propose three-step heuristic to help investors discriminate between genuine premium-bearing spurious products data mining. A robust factor is one whose persistence economic meaning have been studied...

Investors play an important role in combating climate change. The authors examine several types of currently available carbon emissions data their capacity to enable investors incentivize companies reduce emissions. evaluate the information content estimated current and forward-looking from four popular providers. Absent mandatory reporting although many report emissions, much are by Despite providers' claims accuracy, find on (often comprising >50% observations) mostly capture only basic...

In our paper — “How Can ‘Smart Beta’ Go Horribly Wrong?” we show, using U.S. data, that the relative valuation of a strategy (in comparison with its own historical norms) is correlated strategy’s subsequent return at five-year horizon. The high past performance many increasingly popular factor tilt and so-called smart beta2 strategies came, in large measure, from rising valuations. These excess returns are an “alpha mirage” attributable to strategies’ becoming more expensive market. Even...

Traditional capitalization-weighted indices generally add stocks with high valuation multiples after persistent outperformance and sell at low underperformance. It is well known that the price impact of these changes can be large once a change announced. The subsequent reversal less known. For example, in year S&P 500 Index, discretionary deletions beat additions by 22%, on average. Simple rules, such as trading ahead index funds or delaying reconstitution trades 3 to 12 months, up 23 basis...

This article revisits the findings (published in this journal) of Jeffrey and Arnott, who reported that over 95% active managers underperformed a capitalization-weighted index fund on an after-tax basis. The authors posit much has changed quarter century since publishing article, including increased tax awareness part investors advancements efficiency some investment funds vehicles; thus, may now have better opportunity to generate alpha is big enough cover its taxes. measure degree which...

For investors using a core–satellite approach to strategic asset allocation, traditional style indices, such as value and smallcap represent convenient passive vehicles for achieving or even tactical portfolio tilts. In this article, the authors examine indices Fama–French three-factor analysis. They find that most of exhibit negative alpha statistically conclude are suboptimal means creating tilts in portfolios. posit source sub-optimality comes from capweighted construction methodology,...

Value stocks outperform growth stocks. The academic literature provides two competing interpretations on what drives the value premium: exposure to risk factors or mispricing of securities. Existing empirical studies, which are largely based U.S. data, have not conclusively rejected one theory in support other. Up this point, large scale studies multiple countries been conducted. Past also employ data end before 2000 and do cover tech bubble, housing global financial crisis European debt...

This is the first in a series of papers we will publish 2017 that demonstrate factor tilts generally deliver far less alpha live portfolios than they do on paper, or put another way, investment managers fail to capture returns would be expected based their tilts. We break our research into four parts. In this paper show realized by fund differ starkly from theoretical constructed long–short portfolios. Notably, market, value, and momentum factors are rewarding management portfolio returns.

Classical performance attribution methods decompose manager alpha into factor allocation and stock selection components. A can produce through tilts relative to a benchmark by within each factor. However, traditional do not explicitly assess manager’s dynamic skill in the domain. We propose generalized framework for that decomposes effect value-added from both static exposures thus yields additional insight sources of alpha. Such decomposition assist investors identifying quantifying skill,...

We challenge the common view that smart beta strategies and factor tilts are equivalent. Initially, term "smart beta" referred to broke link between price of a stock its weight in portfolio or index. Capitalization weighting does not do — neither applies cap-weighted starting portfolio.

AbstractThis material comments on “A Survey of Alternative Equity Index Strategies”.

Value investing, as defined by the Fama–French HML factor, has underperformed growth investing since 2007, producing a drawdown of 55% mid-2020. The underperformance leads many to argue that value is dead. Our analysis attributes value's recent two sources: book-value-to-price definition fails capture increasingly important intangible assets, and valuations stocks relative have tumbled. Both arguments are inconsistent with death arguments. We capitalize intangibles show this measure...