ERI Scientific Beta

Smart Beta 2.0

ERI Scientific Beta proposes a new approach to investment in smart beta, enabling investors to manage the absolute and relative risks of such investments.

Until now, advocates of smart beta strategies have preferred to highlight the advantages in terms of performance of benchmarks that are less concentrated than cap-weighted indices. This focus has often ignored the consideration of the risks, and especially of their control, that these new forms of indices can represent.

Ultimately, smart beta 1.0 indices are solutions where the choice of risks is imposed upon the investor by the index provider. Whilst risk management lies at the heart of the allocation policies of all institutional investors, smart beta 1.0 indices can seriously undermine appropriate diversification as they overweight equity portfolios with regard to value and liquidity risks.

The second generation of smart beta (2.0) clearly distinguishes between the stock selection and weighting phases. In doing so, it enables investors to choose risks to which they wish or do not wish to be exposed. This distinction is a key element of both risk management and of the performance of smart beta investments, as we demonstrate in an article published in the Journal of Portfolio Management.

This can be completed by a statistical or arithmetical control of relative risk factors (geography, sector) within the actual portfolio optimisation process.

Scientific Beta Indices proposes this double selection and control of risks for the whole range of these flagship Diversified Multi-Strategy indices and Multi-Beta Multi-Strategy indices:

  • Selection of the stock universe (large-cap, mid-cap, high liquidity, mid liquidity, high volatility, low volatility, value, growth, high dividend yield, low dividend yield, high momentum, low momentum, high profitability, low profitability, high investment, low investment)

  • Implementation of a control of relative exposure to risk factors (country or sector neutrality)
These risk choices are at the heart of the construction of the Scientific Beta smart factor indices. The Scientific Beta platform enables investors not only to choose the factors to which they wish to be exposed but also the weighting scheme that ensures good diversification of the index that is representative of this choice of factor.

The strong granularity of the platform thereby allows investors to implement a multi smart factor solution using a top-down approach which enables them, in complete transparency, to define the exposures, the risk allocation constraints and the methods of diversification of specific risk.

As part of its multi-beta index and solution offerings, Scientific Beta provides indices that are representative of its investment philosophy:

  • Exposure to a limited and consensual choice of rewarded factors (Value, Momentum, Low Volatility, Profitability, Investment, and Size).

  • Diminution of the non-rewarded specific risks through a multi-strategy diversification weighting that minimises model risks.

  • The ability to implement allocation techniques that allow the risks of the multi-beta solutions proposed to be controlled.

View "Smart Beta 2.0"

ERI Scientific Beta:

URL for this document:

Hyperlinks in this document: