Edhec-Risk
ERI Scientific Beta



Related Research

EDHEC-Risk Institute has been developing a large body of academic and practitioner research for several years in the field of indexes and benchmarking. A selection of related papers may be found below:

  • The EDHEC European ETF and Smart Beta Survey 2016
    Noël Amenc, Felix Goltz, Veronique Le Sourd
    May 2017

    The EDHEC European ETF and Smart Beta Survey 2016 gathered information from 211 European investment professionals concerning their practices, perceptions, and future plans. Analysis of responses to the survey allowed light to be shed on several important questions regarding investor perceptions on ETFs and smart beta strategies. In particular, fresh insight was gained into the drivers of product adoption by investors and into the challenges investors are faced with when making decisions on implementing passive investing and smart beta strategies.

  • Smart Beta Replication Costs
    Mikheil Esakia, Felix Goltz, Sivagaminathan Sivasubramanian, Jakub Ulahel
    February 2017

    This paper provides an explicit estimate of the costs applied to a range of smart beta strategies and analyses the impact of different implementation rules or stock universes. The objective is to assess transaction costs of smart beta strategies in order to contrast the gross returns of such strategies shown in backtests with estimates of net returns that are actually available to investors when considering transaction costs.

  • Investor Perceptions about Smart Beta ETFs
    Noël Amenc, Felix Goltz, Véronique Le Sourd
    August 2016

    EDHEC-Risk Institute conducted its 9th survey of European investment professionals about the usage and perceptions of ETFs at the end of 2015. The aim of this study was to analyse the usage of exchange-traded funds (ETFs) in investment management and to give a detailed account of the current perceptions and practices of European investors in ETFs. Responses were provided by 219 European investment decision-makers, 180 of which were ETF users. The survey respondents were from 25 different countries, with 41% of them being from the UK and Switzerland. A vast majority of survey respondents were Institutional managers (76%) and more than half of the respondents (51%) were asset managers. For the third year running, in view of the considerable development in new forms of indices, as well as the increasing attention smart beta ETFs have received in the media in the recent years, part of the survey was dedicated to investment professionals’ practices and use of products tracking smart beta indices and on the importance of risk factors in alternative equity beta strategies. The present document is a focus on investor perceptions about smart beta ETFs, as reported by the survey.

  • Ten Misconceptions about Smart Beta: Analysing common claims on performance drivers, investability issues and strategy design choices
    Noël Amenc, Frédéric Ducoulombier, Felix Goltz, Jakub Ulahel
    June 2016

    Smart Beta strategies, as one of the strongest growth areas in investment management recently, have established a space in between traditional (cap-weighted) passive investments and traditional (proprietary and discretionary) active management. Perhaps unsurprisingly, Smart Beta has drawn fierce criticism from both advocates of traditional active management and of traditional passive management. In a nutshell, proponents of proprietary active strategies complain that Smart Beta is not active enough while proponents of traditional cap-weighting say that Smart Beta is not passive enough. Smart Beta providers have not only responded to such criticism, but have also been vocal about the benefits of their respective approaches, without necessarily agreeing with one another. Such debates have too often led to misconceptions. The objective of this paper is to review ten common but mistaken claims about Smart Beta, and to shed light on the underlying issues.

  • Is Smart Beta just Monkey Business? An Analysis of Factor Exposures, Upside-Down Strategies and Rebalancing Effects
    Noël Amenc, Felix Goltz, Ashish Lodh
    November 2015

    “Monkey portfolio” proponents argue that all smart beta strategies generate positive value and small-cap exposure, which fully explains their outperformance. 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 upside-down counterpart, many smart beta strategies display exposure to additional factors, as well as pronounced differences in factor exposures across different strategies.

  • The Limitations of Factor Investing: Impact of the Volkswagen Scandal on Concentrated versus Diversified Factor Indices
    Noël Amenc, Sivagaminathan Sivasubramanian, Jakub Ulahel
    October 2015

    Volkswagen has been caught up in one of the most notorious scandals in corporate history by installing cheat software to reduce emissions during testing. The news broke on the eve of Friday, 18 September 2015 and the stock markets heavily penalised Volkswagen AG and other automobile stocks, including suppliers, on Monday, 21 September 2015. In the present study, we show that, in the month of September 2015, the impact of the Volkswagen scandal is much stronger in concentrated factor indices as opposed to Scientific Beta’s well-diversified smart factor indices which outperformed the cap-weighted benchmark.

  • Active Allocation to Smart Factor Indices
    Noël Amenc, Guillaume Coqueret, Lionel Martellini
    July 2015

    This paper provides a formal empirical analysis of the benefits of strategic and tactical allocation to multiple equity smart factor indices in a context where relative risk with respect to the cap-weighted indices needs to be explicitly controlled for. The focus of this paper is to provide a quantitative assessment of the benefits expected from the three sources of added-value (which come from time-varying strategic, time-varying tactical or time-varying core-satellite allocation decisions) in the design of equity benchmarks with superior risk and return characteristics. The authors show the benefits that active managers and asset owners can expect from dynamically allocating to smart factor indices, with a focus on efficiently reacting to changes in market conditions, as well as efficiently spending relative risk budgets with respect to a cap-weighted reference portfolio.

  • Alternative Equity Beta Investing: A Survey
    Noël Amenc, Felix Goltz, Véronique Le Sourd, Ashish Lodh
    July 2015

    Alternative equity beta investing has attracted increased attention within the industry recently. Though products in this segment currently represent only a fraction of overall assets, there has been tremendous growth recently in terms of both assets under management and new product development. In this context, EDHEC-Risk Institute carried out a survey among a representative sample of investment professionals to identify their views and uses of alternative equity beta.

  • Investor Interest in and Requirements for Smart Beta ETFs
    Felix Goltz, Veronique Le Sourd
    April 2015

    Alternative equity beta investing has received increasing attention in the industry recently. Though products in this segment currently represent only a fraction of overall assets, there has been tremendous growth in terms of both assets under management and new product development. In a survey of investment professionals, EDHEC-Risk Institute solicited the specific views of European ETF investors on “smart beta” exchange-traded funds (ETFs).

  • Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios
    Noël Amenc, Kumar Gautam, Felix Goltz, Nicolas Gonzalez, Jan-Philip Schade
    March 2015

    This paper underlines the usefulness of analysing the performance and risks of portfolios, by taking into account their geographic equity exposure based on real economic activity and not only on their place of listing or, more generally, the nationality assigned to them in market indices. The study finds that, for a number of stocks, their official nationality does not match their real economic exposure as represented by the company’s distribution of sales. A dominant practice in the search for international diversification of equity portfolios is to classify stocks according to their place of listing, incorporation or headquarters. However, such a practice is questionable within the context of a globalised marketplace where a company's operations are typically not restricted to any single country.

  • The Impact of Risk Controls and Strategy-Specific Risk Diversification on Extreme Risk
    Lixia Loh, Stoyan Stoyanov
    August 2014

    This paper furthers the previous analysis by examining the potential tail-risk impact of including country or sector neutrality, tracking error control and strategy-specific risk diversification in smart beta design. The analysis is performed over the ten-year period ending December 2013 for a variety of indices across developed investment universes and the full-range of diversification strategies offered by ERI Scientific Beta. The authors find no evidence that controlling for country or sector risk increases tail risk, whether in terms of absolute or relative returns. Tracking error controls and the diversification of weighting-scheme specific risk by way of equal-weighting the five basic strategies are found to reduce the total tail risk of relative returns (primarily by reducing tracking error itself). This study thus shows that it is possible to impose country or sector risk neutrality on smart beta indices with no adverse impact on tail risk and that tracking error control and the ERI Scientific Beta multi-strategy approach reduce the tail risk of relative returns.

  • Tail Risk of Smart Beta Portfolios: An Extreme Value Theory Approach
    Lixia Loh, Stoyan Stoyanov
    July 2014

    This paper looks at whether the outperformance of smart beta - which typically is demonstrated by advertising a superior Sharpe ratio (i.e. a volatility-risk adjusted performance measure) - persists when one takes extreme risk (i.e. skewness and kurtosis) into account. The authors use the Smart Beta 2.0. framework and the ERI Scientific Beta platform to study the tail risk of smart beta indices for a variety of weighting schemes and factor tilts over the last ten years and across developed investment universes using a methodology which captures the tail behaviour of portfolio losses having explained away the dynamics of volatility (an extension of the GARCH-EVT model introduced in Tail Risk of Equity Market Indices: An Extreme Value Theory Approach, February 2014). Their main finding is that the total extreme risk (relative risk) of diversification strategies is primarily driven by their average volatility (tracking error), which indicates that alternative weighting schemes can deliver superior performance as evidenced by Sharpe or information ratios without increased extreme risks (left tail thickness). The authors also find that factor-tilting produces tail-risks in the total returns of equally-weighted portfolios that are in line with those of cap-weighting, but can produce economically small but statistically significant residual tail risk in relative returns. The latter caveat notwithstanding, this study shows that, at least as far as the ERI Scientific Beta indices are concerned, the over-performance of smart-beta does not come at the cost of higher extreme risk.

  • Risk Allocation, Factor Investing and Smart Beta: Reconciling Innovations in Equity Portfolio Construction
    Noël Amenc, Romain Deguest, Felix Goltz, Ashish Lodh, Lionel Martellini, Eric Shirbini
    July 2014

    This publication argues that current smart beta investment approaches only provide a partial answer to the main shortcomings of capitalisation-weighted (cap-weighted) indices, and develops a new approach to equity investing referred to as smart factor investing. It provides an assessment of the benefits of simultaneously addressing the two main shortcomings of cap-weighted indices, namely their undesirable factor exposures and their heavy concentration, by constructing factor indices that explicitly seek exposures to rewarded risk factors while diversifying away unrewarded risks. The results we obtain suggest that such smart factor indices lead to considerable improvements in risk-adjusted performance. For long-term US data, smart factor indices for a range of different factor tilts roughly double the Sharpe ratio of the broad cap-weighted index. Outperformance of such indices persists at levels ranging from 2.92% to 4.46%, even when assuming unrealistically high transaction costs. Moreover, by providing explicit tilts to consensual factors, such indices improve upon many current smart beta offerings where, more often than not, factor tilts result as unintended consequences of ad hoc methodologies. In fact, this publication shows that by using consensual results from asset pricing theory concerning both the existence of factor premia and the importance of diversification, it is possible to go beyond existing smart beta approaches which provide partial solutions by only addressing one of these issues.

  • Index Transparency – A Survey of European Investors’ Perceptions, Needs and Expectations
    Noël Amenc, Frédéric Ducoulombier
    March 2014

    Between August and November 2013, EDHEC-Risk Institute surveyed 109 institutional investors from across Europe, including Europe’s largest pension and reserve funds, insurance and provident institutions and their asset management subsidiaries, to document their expectations and requirements with respect to index transparency and take stock of their perceptions of, and the extent of their support for, the main directions of the ongoing regulatory debate on indexing and financial benchmarks.

  • Tail Risk of Equity Market Indices: An Extreme Value Theory Approach
    Lixia Loh, Stoyan Stoyanov
    February 2014

    Value-at-risk (VaR) and conditional value-at-risk (CVaR) have become standard choices for risk measures in finance. Both VaR and CVaR are examples of measures of tail risk, or downside risk, because they are designed to exhibit a degree of sensitivity to large portfolio losses whose frequency of occurrence is described by what is known as the tail of the distribution: a part of the loss distribution away from the central region geometrically resembling a tail. In practice, VaR provides a loss threshold exceeded with some small predened probability, usually 1% or 5%, while CVaR measures the average loss higher than VaR and is, therefore, more informative about extreme losses. An interesting challenge is to compare tail risk across different markets. Our paper differs from existing studies in a number of ways. First, we use a much larger global data set and examine left and the right tail of the market index returns in 22 developed and 19 emerging markets. Unlike previous studies, we compare the left and the right tails of different stock markets by carrying out out-of-sample analyses using both VaR- and CVaR-based tests over the full samples and in the period from Jan-2003 to Jun-2013 for which data is available for all markets. We consider three tail probability levels in the calculation of VaR and CVaR: 1%, 2.5%, and 5%.

  • Smart Beta 2.0
    Noël Amenc, Felix Goltz, Lionel Martellini
    April 2013

    This position paper seeks to draw the attention of investors to the risks of traditional smart beta equity indices and proposes a new approach to smart beta investing to take account of these risks. This new approach, referred to as “Smart Beta 2.0,” enables investors to measure and control the risks of their benchmark and revolutionises the offerings of advanced equity benchmarks. The study shows that Smart Beta 1.0 indices present systematic and specific risks that are neither documented nor explicitly controlled by their promoters. This inadequate level of information and of risk management calls into question the robustness of the performance presented and implies considerable risk-taking that is not controlled by investors when they choose new equity benchmarks. In order to deal with this situation, EDHEC-Risk Institute recommends that the choice of systematic risk factors for smart beta benchmarks be clearly explicit. This choice should be made by the investor and not by the index promoter.

  • Assessing the Quality of Asian Stock Market Indices
    Narasimhan Padmanaban, Masayoshi Mukai, Lin Tang, Véronique Le Sourd
    February 2013

    There has been increasing demand for equity indices in Asia. This is because global investors wish to benefit from the region’s growth, and consequently from its financial markets. As many US- and Europe-based investors do not have the expertise to conduct stock picking in Asia, equity investments are often passive for Asian-oriented portfolios. Therefore, the question of index quality in Asia is an important issue. This study addresses that question by focusing on three aspects: efficiency, concentration and stability, reporting the results for 10 major Asian stock market indices over the past decade.

  • Choose Your Betas: Benchmarking Alternative Equity Index Strategies
    Noël Amenc, Felix Goltz, Ashish Lodh
    Journal of Portfolio Management
    Fall 2012

    This article clarifies that methodological choices can be made independently for two steps in the construction of alternative equity index strategies: the constituent selection and choice of a diversification-based weighting scheme. By flexibly combining the different possible choices for these steps, the authors create a large variety of strategies and test their performance and risk results. The results suggest that diversification approaches may be a superior alternative, or at least a very important complement, to pure stock selection approaches when it comes to reaching a risk-return objective. Moreover, even though some argue that the risk and performance of diversification-based weighting schemes are solely driven by factor tilts, the authors show how straightforward it is to correct such tilts through the selection of stocks with appropriate characteristics while maintaining the improvement in achieving a risk–return objective that is due to the respective diversification approaches.

  • EDHEC-Risk Asian Index Survey 2011
    Noël Amenc, Felix Goltz, Masayoshi Mukai, Padmanaban Narasimhan, Lin Tang
    May 2012

    This is the first comprehensive survey of Asian investment professionals that identifies the criteria investors use to assess and select stock and bond indices, measures satisfaction of Asian investors with existing indices, and documents their segmentation practices. It includes comparisons with results from sister surveys of European and North-American investors. The 127 Asian investment professionals, representing asset managers, institutional investors, investment consultants, and private wealth managers, who responded to the survey are principally from the three asset management hubs in the Asia Pacific region (Australia, Singapore and Hong Kong), but a wide range of other countries are represented, including India, China, Japan and New Zealand. This new survey-based evidence will be useful to Asian investors who wish to benchmark their indexation practices to research advances as well as to the practices of their peers in the region and globally. It will also provide much-needed information to providers of investment solutions who want to better address the needs of Asian investors.

  • EDHEC-Risk North American Index Survey 2011
    Noël Amenc, Felix Goltz, Lin Tang, Vijay Vaidyanathan
    April 2012

    As the choice of an index is a crucial step in both asset allocation and performance measurement, it is useful to investigate index use and perceptions about indices. The EDHEC-Risk North American Index Survey 2011 aims to analyse the current uses of and opinions on stock, bond and equity volatility indices. While information on index vehicles is widely available, particularly in the case of exchange-traded vehicles, the objective of the survey is to provide unique insight into the users’ perspective in the index industry, not only including a description of the current practices, but also user perceptions on different indices and on benefits and drawbacks of index construction methodologies. Furthermore, there is a growing body of research on index construction and index use. Recent studies assess current indices and also propose alternative approaches to construct indices. This survey also serves as a tool to explore views of institutional index users on the conclusions of the literature in financial research. The survey elicited responses from 139 North American investment professionals. Overall, the respondents represent approximately $12 trillion worth of assets under management (AUM). This, in turn, represents around one third of all AUM in the North American asset management industry.

    A paper based on this study was published in the March/April 2013 issue of the Journal of Indexes.

  • Diversifying the Diversifiers and Tracking the Tracking Error: Outperforming Cap-Weighted Indices with Limited Risk of Underperformance
    Noël Amenc, Felix Goltz, Ashish Lodh, Lionel Martellini
    Journal of Portfolio Management
    Spring 2012

    A number of quantitative or fundamental weighting schemes have been shown to produce robust outperformance with respect to standard cap-weighted equity indices over long time periods. Over periods ranging from a few months to a few years, however, such alternative weighting schemes can generate substantial downside risk relative to cap-weighted indices, which would be a source of concern for most investment managers or chief investment officers. In this article, the authors focus on two reasonable proxies for well-diversified, efficient frontier portfolios, namely, the maximum Sharpe ratio (MSR) portfolio and the global minimum volatility (GMV) portfolio. They address the question of how to use these building blocks to design an improved equity benchmark while satisfying target levels of average and extreme tracking error with respect to cap-weighted indices. The authors find that robust proxies for the GMV portfolio provide defensive exposure to equity that does well in adverse market conditions, while robust proxies for MSR portfolios provide greater access to the upside of equity markets. Because the relative performance of these two diversification approaches depends on market conditions, they expect a combination of both approaches to lead to a smoother conditional performance and higher probability of outperformance of the cap-weighted index, an intuition that is confirmed in empirical tests. Empirical analysis also suggests that “diversifying the diversifiers” still leads to high levels of relative downside risk, in particular when the performance of cap-weighted indices is unusually strong. In this context, the authors introduce an explicit relative risk control mechanism designed to reduce the consequences of severe short-term underperformance with respect to the cap-weighted index and confirm through out-of-sample empirical tests that “tracking the tracking error” would allow investors to achieve better access to outperformance per unit of extreme relative risk taken. Overall, the results reported in this article suggest that it is possible to achieve robust outperformance versus cap-weighted indices by diversifying model risk and by controlling relative risk compared to the cap-weighted indices.

  • EDHEC-Risk European Index Survey 2011
    Noël Amenc, Felix Goltz, Lin Tang
    October 2011

    The EDHEC-Risk European Index Survey 2011 aims to provide unique insight into the users’ perspective in the European index industry by analysing the current uses of and opinions on stock, bond and equity volatility indices. Furthermore, there is a growing body of research on index construction and index use. Recent studies assess current indices and also propose alternative approaches to construct indices. This survey also serves as a tool to explore views of institutional index users on the conclusions of the literature. This survey enabled opinions from 104 institutional investment managers to be gathered, which represent approximately seven trillion Euros of assets under management. This represents more than half of all assets under management by the European asset management industry. The respondents are from asset management companies, pension funds and insurance firms located all over Europe. The opinions collected reflect investors’ overall judgement on index quality, on the key issues they see with current indices, and the likely future trends for the index landscape.

    An article based on this survey was published in the Summer 2012 issue of the Journal of Index Investing.

  • Improved Beta? A Comparison of Index-Weighting Schemes
    Noël Amenc, Felix Goltz, Lionel Martellini, Shuyang Ye
    September 2011

    This paper analyses a set of equity indices whose aim is to improve on capitalisation weighting and thus to provide “improved beta”. Four main weighting schemes are analysed: efficient indices, fundamental indices, minimum-volatility indices, and equal-weighted indices. Empirical results for US and Developed World data on these indices show that the average returns of all four alternative index construction methods are superior to those of cap-weighted equity indices in both universes and that, by several measures of risk-adjusted performance, they are likewise superior.

    The paper also analyses factor exposures of alternative weighting schemes. Only the fundamental index has a value exposure that is substantially greater than that of the equal-weighted index. Other non-cap-weighted indices such as efficient indexation and minimum volatility have value exposures that are comparable to that of equal weighting. Since the indices studied here are made up of large-cap stocks, none of these indices shows any economically meaningful bias towards small caps. Interestingly, the minimum-volatility index, similar to the cap-weighted indices, shows a negative small-cap exposure since it favours the largest stocks.

    A revisited version of this paper was published in the January/February 2011 issue of the Journal of Indexes.

  • Does Finance Theory Make the Case for Capitalisation-Weighted Indexing?
    Felix Goltz, Véronique Le Sourd
    January 2010

    Proponents of cap-weighted stock market indices often argue that such indices provide efficient risk/return portfolios. This paper reviews the evidence in the academic literature and concludes that only under very unrealistic assumptions would such indices be efficient investments. In the presence of realistic constraints and frictions, cap-weighted indices cannot, according to the academic literature, be expected to be efficient investments.

    The three main conclusions of the research are the following:

    • A cap-weighted stock market index is not the market portfolio of financial theory (the Capital Asset Pricing Model (CAPM) theory is often evoked to show that cap-weighted stock market indices are efficient portfolios and attractive investments). That it is not is clear from the choices made in empirical studies that attempt to come up with reasonable proxies for the market portfolio. These studies attach great importance to including many more stocks than indices do, and their proxies of the market portfolio include bonds, real estate, and non-tradable assets such as human capital.

    • Even if it were possible to construct and hold the market portfolio, the theory does not predict that the market portfolio is efficient unless we make highly unrealistic assumptions. In fact, the authors of the seminal academic research in the 1950s and 1960s, Harry Markowitz and William Sharpe, have themselves emphasised (Sharpe (1991) and Markowitz (2005)) that the market portfolio may not be efficient in a more realistic setting.

    • In view of these arguments, financial theory alone does not justify the current practice of capweighting. In fact, from a theoretical perspective, cap-weighted stock market indices seem to offer no particular advantage.

    A revisited version of this paper was published in the Fall 2011 issue of the Journal of Index Investing.

  • Efficient Indexation: An Alternative to Cap-Weighted Indices
    Noël Amenc, Felix Goltz, Lionel Martellini, Patrice Retkowsky
    January 2010

    This paper introduces a novel method for the construction of equity indices that, unlike their cap-weighted counterparts, offer an efficient risk/return tradeoff. The index construction method goes back to the roots of modern portfolio theory and focuses on the tangency portfolio, the portfolio that weights index constituents so as to obtain the highest possible Sharpe ratio. The major challenge is to generate the required input parameters in a robust manner.

    The expected excess return of each stock is estimated from portfolio sorts according to the stock’s total downside risk. This estimate uses the economic insight that stocks with higher risk should compensate their holders with higher expected returns. To estimate the covariance matrix, we use principal component analysis to extract the common factors driving stock returns. Moreover, we introduce a procedure to control turnover in order to implement the method with low transaction costs. Our empirical results show that portfolio optimisation with our robust parameter estimates generates out-of-sample Sharpe ratios significantly higher than those of the corresponding cap-weighted indices. In addition, the higher risk/return efficiency is achieved consistently and across varying economic and market conditions.

    A revisited version of this paper was published in the Fourth Quarter 2011 issue of the Journal of Investment Management.

  • A Comparison of Fundamentally Weighted Indices: Overview and Performance Analysis
    Noël Amenc, Felix Goltz, Véronique Le Sourd
    March 2008

    This paper analyses a set of characteristics-based indices that have recently been launched on the US market and have been said to outperform standard market cap-weighted indices over particular backtest samples. It analyses the performance of an exhaustive list of such indices and shows that:

    • The outperformance over value-weighted indices may be negative over long time periods and that

    • Characteristics-based indices do not significantly outperform simple equal-weighted indices.

    Furthermore, an analysis of both the style exposures and the sector exposures of characteristics-based indices reveals a significant value tilt. When properly adjusting for this tilt, these indices do not show any abnormal performance. Therefore, the paper argues that the main value added of these indices may be to provide investors with a liquid, systematic, and relatively cheap alternative to other value-tilted strategies. However, it should also be noted that if one recognises the potential to tilt exposures to sector or style factors, it is straightforward to construct factor portfolios that beat the characteristics-based indices in the sense of mean-variance efficiency.

    A revisited version of this paper was published in the March 2009 issue of European Financial Management.

  • Fundamental Differences? Comparing Alternative Index Weighting Mechanisms
    Noël Amenc, Felix Goltz, Véronique Le Sourd
    April 2008

    While an ever increasing share of equity assets is invested in indexing strategies, the standard practice of using capitalisation weighting to construct stock market indices has been the object of much criticism.1 In response to this criticism, equity indices with different weighting schemes have emerged. Some indices use "fundamental" metrics (Arnott, Hsu, and Moore 2005) to weight the component stocks. In recent years, the market for such characteristics-based indices has grown tremendously, with more and more providers launching and offering them. Institutional investors have allocated significant amounts to these alternatives to value-weighted indices. Likewise, a wide range of exchange-traded funds on these new indices is now available. Whether or not characteristics-based indices perform better than capitalisation-weighted indices is, ultimately, an empirical question. While the different providers assess the performance of their own indices, no extensive assessment or comparison involving indices from different providers has been done so far. EDHEC has studied the risk and return properties of these new indices, using an extensive database of 14 characteristics-based indices that are calculated by seven different providers.

  • Reactions to the EDHEC study "Assessing the Quality of Stock Market Indices"
    Felix Goltz, Guang Feng
    September 2007

    A recent publication by EDHEC-Risk Institute has drawn conclusions that highlight the shortcomings of well known capitalisation- or price-weighted stock market indices and argues that the choice of benchmark for asset allocation or performance measurement is a task requiring particular care.

    In a call for reactions to this publication, EDHEC-Risk Institute finds that the answers of the more than eighty respondents (asset management firms, pension funds, insurance companies, private banks, etc.) tend to reinforce the conclusions drawn by the original publication.

    Although it would at first appear that the majority of respondents are not, in general, dissatisfied with the indices they use as benchmarks (18.82% of respondents express degrees of dissatisfaction), further examination soon reveals that the shortcomings of these indices, such as inefficiency, lack of stability, and susceptibility to price bubbles, are widely recognised by the industry professionals responding to EDHEC-Risk's call for reactions. The call for reactions also shows that a considerable majority of respondents plan to review the indices they use as benchmarks, either immediately or in the future.

  • Assessing the Quality of Stock Market Indices: Requirements for Asset Allocation and Performance Measurement
    Noël Amenc, Felix Goltz, Véronique Le Sourd
    September 2006

    For the vast majority of European institutional investors, constructing a benchmark and measuring the performance of their portfolio in relation to the benchmark are central to their investment process. And, very often, the chosen benchmark is a market index and/or a combination of market indices. Since their design is not affected by the securities chosen by managers and since they benefit from the sound reputation of major financial institutions, credit rating agencies and major international stock exchanges, market indices appear to be the ultimate reference not only for strategic allocation but also as a measure of investment management performance. Evaluating the quality of these indices as a benchmark is therefore a question that is essential to institutional investors.

    The results of this study clearly show that most market indices used as a reference by investors are neither efficient nor stable in terms of style and sector exposure. This inefficiency and instability is a source of underperformance and poor risk management and results in a failure by investors to optimise the risk-return trade-off of their portfolios.


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