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Why Factor Tilts Are Not Smart “Smart Beta”Our analysis of three first-generation smart beta strategies shows factor-replicated portfolios are ineffective substitutes for their smart beta counterparts, exhibiting poorer performance, high turnover, and low capacity.
Why Factor Tilts Are Not Smart “Smart Beta”We challenge the common view that “smart beta” strategies and factor tilts are the same. In fact, factor-replicated portfolios are poor substitutes for their smart beta counterparts. Performance is poor, turnover is high, and capacity is terrible. Why? Implementation details matter—both for performance and for trading costs.
The Incredible Shrinking Factor ReturnManagers who favor high factor loadings on market beta, value, or momentum generally do not derive nearly as much incremental return as theoretical factor return histories would suggest, and the culprit appears to be the real-world costs of implementation.
Take the 5% Challenge! (or The “Lloyd Christmas” Lesson)Most retirement calculators and pension plans target a return after inflation of 5%. Mainstream asset classes producing rock-bottom yields will be hard pressed to deliver. It’s time to get real. Take the 5% Challenge. Use our portfolio builder—and our expected returns—to calculate the probability of your portfolio earning a 5% real return.
2016 GRAHAM & DODD SCROLL AWARD OF EXCELLENCE
Will Your Factor Deliver? An Examination of Factor Robustness and Implementation CostsNot every factor profits investors when implemented through a passive strategy. Size and quality show weak robustness, and liquidity-demanding factors, such as illiquidity and momentum, are associated with high trading costs. Investors may be better off accessing these factors through active management rather than indexation. Published in the Financial Analysts Journal by Jason Hsu, Vitali Kalesnik, Noah Beck, and Helge Kostka.
Forecasting Smart Beta and Factors: History Is Worse than UselessPast is NOT prologue. With the proliferation of smart beta and factor strategies, investors should be vigilant to the pitfalls of data mining and performance chasing. Relative valuations can predict the long-term future returns of strategies and factors —not with any short-term precision— but well enough to add material value. Useful forecasting models should furthermore address implementation costs.
Charting the Journey in Smart BetaHistorical factor returns—net of changes in valuation levels—are much lower than recent performance suggests. In fact, many of the most popular new factors (some 458 at last count) have succeeded solely because they have become more expensive. This trend matters to investors because rising valuation levels inflate past performance, reduce potential future performance, and amplify the risk of mean reversion to historical valuations.
Rethinking Conventional Wisdom: Why NOT a Value Bias?Not all long-term sources of excess return are treated equally in portfolios, frustrating investors’ ability to meet their financial goals. Asset owners and their agents need to act now to address the primary sources of this disconnect: cognitive bias and principal–agent conflict.
Record Low Costs to Trade!Mean reversion is as applicable to trading costs as it is to valuation. Today’s costs to trade are at 56-year historical lows; they are due to rise soon. Now is the time to position your portfolio ahead of expected higher costs to trade and lower equity prices.
Next Season’s Meager Harvest in Commercial Real EstateUS commercial property investors reaped high real returns over the last five years, but the climate is changing. Property prices are high, yields are low, and future expected returns portend a scantier harvest over the coming decade.
Systematic Global MacroThe alternative factor premia of carry, momentum, and value may be combined to produce an attractive and diversifying source of investment return relative to the low yields and low returns of mainstream stocks and bonds.
How Not to Get Fired with Smart Beta InvestingInvestors in smart beta strategies will and should expect bouts of underperformance, according to John West. In anticipation of this, owners and agents are encouraged to align their respective incentives and long-term interests.
Dynamic Multi-Factor InvestingChris Brightman asserts that multi-factor equity investing and rebalancing using robust factors is a reliable strategy for outperforming the market without the burden of excessive volatility.
Forecasting Smart BetaRob Arnott explains why “history is worse than useless” in forecasting the alpha of smart beta strategies.
RAFI StrategiesRAFI strategies aim to generate excess returns versus the market benchmark through a systematic, contrarian rebalancing approach.
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All AssetAll Asset strategies are global tactical asset allocation (GTAA) solutions that aim to deliver attractive real returns, equity diversification, and inflation protection via tactical long-only exposures.
RAE™RAE systematic active equity strategies seek to generate superior risk-adjusted returns.
Global MacroThe Global Macro strategy aims to deliver uncorrelated absolute returns through leveraged long–short exposures to liquid derivatives contracts.
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