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Alice in Factorland

Factor tilt strategies have generally produced less alpha in live portfolios compared to theoretical factor long–short paper portfolios and have largely been unsuccessful in replicating smart beta strategies. End-investors, consequently, often reap a much smaller return from factor exposure than they expect. The winning approach to factor investing is buying the losers: Past negative performance appears to be predictive of positive future returns. 

Articles

Why Factor Tilts Are Not Smart “Smart Beta”

By Rob Arnott Mark Clements Vitali Kalesnik

May 2017 | Read Time: 15 min

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.



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(VIDEO) 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.

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Articles

The Incredible Shrinking Factor Return

By Rob Arnott Vitali Kalesnik Lillian Wu

April 2017

Managers 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.



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(VIDEO) Alice in Factorland and the Incredible Shrinking Factor Return
Research by Rob Arnott, Vitali Kalesnik, and Lillian Wu shows that factor-tilt strategies suffer from substantial return slippage (vs. factor long–short paper portfolios) due to the real-world costs of implementation.



Visual Insights

Managers experience slippage in their ability to capture factor returns.

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