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Alternative Equity Beta Investing: a Survey

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Alternative Equity Beta Investing: a Survey An EDHEC-Risk Institute Publication Alternative Equity Beta Investing: A Survey July 2015 with the support of Institute Printed in France, July 2015. Copyright EDHEC 2015. The opinions expressed in this study are those of the authors and do not necessarily reflect those of EDHEC Business School. 2 This research is conducted as part of the Sociéte Générale Prime Services "Advanced Modelling for Alternative Investments" research chair at EDHEC-Risk Institute. Alternative Equity Beta Investing: A Survey — July 2015 Table of Contents Executive Summary .................................................................................................5 Introduction ...............................................................................................................17 Part I: Conceptual Background: The Forms of Smart and Alternative Beta in the Equity Univers ............................................................................................. 21 1. The Emergence of Alternatives to Cap-weighted Indices .................................. 23 2. Equity Risk Factors and Factor Indices ................................................................... 31 3. Diversification Strategy Indices ............................................................................. 83 4. Portfolio Construction Across Alternative Equity Beta Strategies .............. 95 Part II: Survey: Use of Smart Equity Beta Strategies and Perceptions of Investment Professionals ............................................................................... 107 1. Methodology and Data ................................................................................................109 2. Which Types of Alternative Equity Beta are Investors Using? ........................ 113 3. Challenges Facing Investors ....................................................................................... 119 4. The Importance of Factors in Alternative Equity Beta Strategies .................131 Appendix ................................................................................................................. 135 References ............................................................................................................... 145 About Société Générale Prime Services .......................................................... 161 About EDHEC-Risk Institute ............................................................................. 165 EDHEC-Risk Institute Publications and Position Papers (2012-2015) ..... 169 An EDHEC-Risk Institute Publication 3 Alternative Equity Beta Investing: A Survey — July 2015 About the Authors Noël Amenc is a professor of finance at EDHEC Business School, director of EDHEC-Risk Institute, and chief executive officer of ERI Scientific Beta. He has conducted active research in the fields of quantitative equity management, portfolio performance analysis, and active asset allocation, resulting in numerous academic and practitioner articles and books. He is on the editorial board of the Journal of Portfolio Management and serves as associate editor of the Journal of Alternative Investments and the Journal of Index Investing. He is a member of the Monetary Authority of Singapore Finance Research Council and the Consultative Working Group of the European Securities and Markets Authority Financial Innovation Standing Committee. He co-heads EDHEC-Risk Institute’s research on the regulation of investment management. He holds a master’s in economics and a PhD in finance from the University of Nice. Felix Goltz is head of applied research at EDHEC-Risk Institute. He carries out research in empirical finance and asset allocation, with a focus on alternative investments and indexing strategies. His work has appeared in various international academic and practitioner journals and handbooks. He obtained a PhD in finance from the University of Nice Sophia-Antipolis after studying economics and business administration at the University of Bayreuth and EDHEC Business School. Véronique Le Sourd has a Master’s Degree in applied mathematics from the Pierre and Marie Curie University in Paris. From 1992 to 1996, she worked as a research assistant in the finance and economics department of the French business school HEC and then joined the research department of Misys Asset Management Systems in Sophia Antipolis. She is currently a senior research engineer at EDHEC-Risk Institute. Ashish Lodh is senior quantitative analyst. He does research in empirical finance, focusing on equity indexing strategies and risk management. He has a master’s in management with a major in finance from ESCP Europe. He also has a bachelor’s degree in chemical engineering from Indian Institute of Technology. 4 An EDHEC-Risk Institute Publication Executive Summary An EDHEC-Risk Institute Publication 5 Alternative Equity Beta Investing: A Survey — July 2015 Executive Summary Alternative equity beta investing has do not consider a diversification-based attracted increased attention within the objective, on the other hand, may result industry recently. Though products in this in highly concentrated portfolios to achieve segment currently represent only a fraction their factor tilts. More recently, investors of overall assets, there has been tremendous have started to combine both factor growth recently in terms of both assets tilts and diversification-based weighting under management and new product schemes to produce well-diversified development. In this context, EDHEC-Risk portfolios with well-defined factor tilts, recently carried out a survey1 among a using a flexible approach referred to as representative sample of investment Smart Beta 2.0. This approach, in particular, professionals to identify their views allows the design of factor-tilted indices and uses of alternative equity beta. This (by using a stock selection based on factor- executive summary provides an overview related stock characteristics) which are of the background research, as well as the also well diversified (through the use of main results of this survey. a diversification-based weighting scheme among the stocks with the desired factor While “smart beta” is used broadly in the exposures). Such an approach is also industry as a catch-all phrase for new referred to as “smart factor investing” as it 1 - Amenc, N., F. Goltz, indexation approaches that deviate from combines both the smart weighting scheme V. Le Sourd, A. Lodh. 2015. Alternative Equity Beta broad cap-weighted market indices, a and the explicit factor tilt (see Amenc et Investing: A Survey. recent trend is the appearance of factor al. (2014a)). More recently, investors have EDHEC-Risk Publication produced with the support indices that specifically target certain been increasingly turning their attention of Société Générale Prime rewarded risk factors. In fact, the early Services. The survey was to allocation decisions across such factor conducted in 2014. generation of smart beta approaches investing strategies to generate additional (Smart Beta 1.0) aimed to either improve value-added (see Amenc et al. (2014d)). The portfolio diversification relative to heavily background section to our survey reviews concentrated cap-weighted indices the research on advanced beta equity (examples of such approaches are equal- strategies to provide a comprehensive weighting or equal-risk contribution, to discussion of potential benefits and risks, name but two) or to capture additional as well as implementation challenges with factor premia available in equity markets such strategies. (such as value indices or fundamentally- weighted indices, which aim to capture the Investment practices in alternative equity value premium). beta strategies are currently evolving at a fast pace, in line with an increasing variety of A potential shortcoming of focusing only on product offerings, and our survey was thus either improving diversification or capturing not aimed at providing a definitive account factor exposures is that the outcome, of practices in this area. However, with though improving upon broad cap-weighted offerings and communication by providers indices, may be far from optimal. In fact, increasing, the discussion of such strategies diversification-based weighting schemes rarely provides a buy-side perspective. Our will necessarily result in implicit exposure survey aims to fill this gap and provide the to certain factors, thus carrying the risk investors’ perspective on such strategies. In of unintended consequences for investors our survey, we prefer the term “alternative who may not be aware of the implicit factor equity beta” to refer to such strategies. exposures. Factor-tilted strategies, which The objective of our survey was to gain 6 An EDHEC-Risk Institute Publication Alternative Equity Beta Investing: A Survey — July 2015 Executive Summary insights into investor perceptions relating Evolution of Multi-Factor Asset to such advanced beta equity strategies, Pricing Models but also into the current uses they make of Asset pricing theory postulates that such strategies. We cover both long-only multiple sources of systematic risk are strategies and long/short strategies but priced in securities markets. In particular, focus specifically on equity investments, both equilibrium models such as Merton’s and deliberately omit questions concerning (1973) Intertemporal Capital Asset Pricing alternative beta strategies in other asset Model and arbitrage models such as classes. We asked respondents about their Ross’s (1976) Arbitrage Pricing Theory current
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