Smart beta indexes may not provide true exposure to factors, according to research from Robeco Asset Management.
While the amount of exposure indexes provide differs “considerably,” none of the most popular strategies “unlock the full potential offered by factor premiums,” argued David Blitz, head of quantitative equity research at Robeco.
“Many smart beta strategies do not offer maximum factor exposure, but still contain a significant amount of market index exposure as well, or some unexpected exposures to other factors,” he wrote.
“Many smart beta strategies… still contain a significant amount of market index exposure as well, or some unexpected exposures to other factors.”For the study, Blitz compared value, momentum, low-volatility, profitability, and investment factor portfolios with corresponding Russell, S&P, and MSCI smart beta indexes. Though most of the indexes were “quite suitable” for obtaining factor exposure, they “fall short of offering maximum exposure to these factors,” he wrote.
The Russell 1000 Value index, for example, carried only a 36% exposure to the value factor. Meanwhile, it was exposed 23% to the market, 21% to the investment factor, and 20% to the low-volatility factor.
“The Russell 1000 Value index provides highly diffuse factor exposures, and that is not very suitable for investors seeking pure and sizeable exposure to the value factor,” Blitz argued.
MSCI’s value-weighted index, on the other hand, offered more pure value exposure than its Russell counterpart—but its market exposure was 60%.
Even momentum and low-volatility indexes from MSCI and S&P, respectively, which offered among the highest exposures to their designated factors, remained more correlated to the market than pure factor portfolios.
“Altogether, these results imply that smart beta indexes may be used to harvest generic factor premiums, but also that it is crucial to properly understand the characteristics of these indexes in order to get the intended factor exposures,” Blitz concluded.
Read the full paper, “Factor Investing with Smart Beta Indices”.
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