Equity Smart Beta and Factor Investing for Practitioners. Edition No. 1

Table of Contents

Acknowledgments xiii

Disclaimer xv

Introduction 1

Part I Overview of Equity Smart Beta Space

Chapter 1 Evolution and Composition of the Equity Smart Beta Space 11

I. Introduction 12

II. Evolution of Equity Smart Beta 13

III. Desired Characteristics of Smart Beta Strategies 19

IV. Composition and Definition of Equity Smart Beta 21

V. Typical Investor Questions 21

VI. Conclusion 30

Part II Equity Common Factors and Factor Investing

Chapter 2 An Overview of Equity Common Factors and Factor Investing 35

I. Introduction: What Are Equity Common Factors? 36

II. Evolution of Equity Common Factors and Factor

Investing 37

III. Typical Investor Questions 49

IV. Conclusion 53

Chapter 3 Explaining Smart Beta Factor Return Premia 55

I. Introduction 56

II. Data Mining 57

III. Risk-Based Explanations 58

IV. Behavioral Explanations 59

V. Structural Explanations 62

VI. Typical Investor Questions 63

VII. Conclusion 68

Part III Capturing Smart Beta Factors

Chapter 4 Weighting Schemes 71

I. Introduction 73

II. Weighting Schemes Used to Capture Factor Returns 73

III. Assessing the Investment Performance and Efficiency of Weighting Schemes Used to Capture Factor Returns 82

IV. Typical Investor Questions 96

V. Conclusion 101

Chapter 5 Factor Specifications 109

I. Introduction 110

II. Value 111

III. Momentum 114

IV. Low Volatility 115

V. Quality 116

VI. Typical Investor Questions 119

VII. Conclusion 122

Chapter 6 Active Risk and Return Decomposition of Smart Beta and Active Strategies 125

I. Introduction 127

II. Risk Decomposition of Smart Beta Strategies 127

III. Risk Decomposition of Active Strategies 134

IV. Typical Investor Questions 142

V. Conclusion 148

Part IV Performance Characteristics of Smart Beta Factor Strategies

Chapter 7 Performance Characteristics of Individual Smart Beta Factors 151

I. Introduction 152

II. After-Cost Performance: Accounting for Implementation Costs 154

III. After-Cost Performance Characteristics 158

IV. Typical Investor Questions 168

V. Conclusion 171

Chapter 8 Performance Characteristics of Factor Diversification Strategies 173

I. Introduction 175

II. Active Return Correlations 175

III. Performance Characteristics of Factor Diversification Strategies 179

IV. Constructing Diversification Strategies: The Portfolio Blending versus Signal Blending Debate 197

V. Typical Investor Questions 202

VI. Conclusion 209

Chapter 9 The Low-Volatility Anomaly 211
Roger G. Clarke, Research Consultant, Analytic Investors
Harindra de Silva, Portfolio Manager, Analytic Investors/Wells Fargo Asset Management
Steven Thorley, H. Taylor Peery Professor of Finance, Marriott School of Business, Brigham, Young University

I. Introduction 211

II. Historical Manifestation of the Low-Volatility Factor 212

III. How Is “Low Volatility” Defined? 214

IV. Secondary Factors of Low-Beta Portfolios 218

V. Building a Low-Volatility Portfolio 224

VI. Publicly Available Low-Volatility ETFs 226

VII. Summary and Conclusion 226

Part V Smart Beta Implementation

Chapter 10 Structuring Better Equity Portfolios: Combining Smart Beta with Smart Alpha 231

I. Introduction 232

II. Current Portfolio Structuring Practices 233

III. Portfolio Structuring: A Suggested Framework 235

IV. Typical Investor Questions 246

V. Conclusion 258

Chapter 11 Incorporating ESG with Smart Beta 261

I. Introduction 262

II. ESG Data 263

III. Incorporating ESG Strategies 264

IV. Incorporating ESG with Smart Beta 273

V. Typical Investor Questions 277

VI. Conclusion 281

Chapter 12 An Alternative to Hedge Fund Investing: A Risk-Based Approach 283

I. Introduction 283

II. Benefits of a Diversified Portfolio of Hedge Funds 286

III. Systematic Drivers of Hedge Fund Performance 296

IV. Liquid Tracking Portfolio Simulated Performance 301

V. Developments in the Hedge Fund Industry 309

VI. Conclusion 314

Part VI Asset Owner Perspectives

Chapter 13 Implementing Smart Beta at CalPERS, a Conversation with Steve Carden 319
Investment Director, Global Equities, California Public Employees Retirement System

Chapter 14 A Pension Fund’s Journey to Factor Investing: A Case Study 331
Hans de Ruiter, Chief Investment Offi cer, Stichting Pensioenfonds TNO; Associate Professor, Vrije Universiteit Amsterdam

I. Introduction 331

II. The Case for Passive Market Cap-Weighted Strategies 332

III. Are Smart Beta Strategies the Better Alternative? 333

IV. Practical Considerations 337

V. Conclusion 341

Chapter 15 Using Smart Beta for Efficient Portfolio Management 343
Ilian Dimitrov, Head of Growth Assets, Oak Pension Asset Management Limited; Vice President, Investments, Barclays Bank UK Retirement Fund

I. Introduction 343

II. Motivation and Strategy Selection 344

III. Challenges 344

IV. Product Selection 345

V. Smart Beta Allocation 347

VI. Governance, Monitoring, and Performance Benchmarking 348

VII. Conclusion 348

Part VII Consultant Perspectives

Chapter 16 Smart Beta from an Asset Owner’s Perspective 351
James Price, Director, Willis Towers Watson
Phil Tindall, Senior Director, Willis Towers Watson

I. The Smart Beta Revolution or Evolution? 351

II. Smart Beta from the Asset Owner Perspective 356

III. Asset Owners Face New Challenges When Using Smart Beta Strategies 364

IV. Future Developments 367

V. Concluding Thoughts 371

Chapter 17 Smart Beta: The Space Between Alpha and Beta 373
Andrew Junkin, President, Wilshire Consulting
Steven Foresti, Chief Investment Offi cer, Wilshire Consulting
Michael Rush, Vice President, Wilshire Consulting

I. Factors: The Building Blocks of Portfolios 375

II. Alpha or Beta? 375

III. Equity Factor Investing: An Example 377

IV. Performance of Key Equity Factors 377

V. Implementation of Smart Beta 379

VI. Smart Beta Case Study: A Potential Complement to Traditional Active Management 383

VII. The Pros and Cons of Smart Beta 385

VIII. Conclusion 387

Part VIII Retail Perspectives

Chapter 18 Smart Beta Investing for the Masses: The Case for a Retail Offering 395
Lisa L. Huang, Head of Artifi cial Intelligence Investment Management and Planning, Fidelity Investments
Petter N. Kolm, Director of the Mathematics in Finance Master’s Program and Clinical Professor, Courant Institute of Mathematical Sciences, New York University

I. Introduction to Factor Investing and Smart Beta 396

II. Why Provide a Smart Beta Strategy in Today’s Retail Market? 399

III. Challenges in Developing a Smart Beta Portfolio Strategy for Retail Investors 401

IV. Implementing a Smart Beta Portfolio Strategy as a Fiduciary Advisor 402

V. A Look into the Future 407

VI. Conclusion 409

Chapter 19 Positioning Smart Beta with Retail Investors, a Conversation with Jerry Chafkin 411
Chief Investment Officer, AssetMark

Part IX Concluding Remarks

Chapter 20 Addressing Potential Skepticism Regarding Smart Beta 425

I. Skepticism Regarding Factor Existence 425

II. Skepticism Regarding Implementation 426

III. Skepticism Regarding Factor Persistence 429

IV. Conclusion 430

Chapter 21 Conclusion 431

About the Authors 433

Bibliography 447

Additional Disclaimers 459

Index 463

Authors