Equity Smart Beta and Factor Investing for Practitioners

Acknowledgments xiii Disclaimer xv Introduction 1 Part I Overview of Equity Smart Beta Space Chapter 1 Evolution and Composition of the Equity Smart Beta Space 11 I. Introduction 12 II. Evolution of Equity Smart Beta 13 III. Desired Characteristics of Smart Beta Strategies 19 IV. Composition and Definition of Equity Smart Beta 21 V. Typical Investor Questions 21 VI. Conclusion 30 Part II Equity Common Factors and Factor Investing Chapter 2 An Overview of Equity Common Factors and Factor Investing 35 I. Introduction: What Are Equity Common Factors? 36 II. Evolution of Equity Common Factors and Factor Investing 37 III. Typical Investor Questions 49 IV. Conclusion 53 Chapter 3 Explaining Smart Beta Factor Return Premia 55 I. Introduction 56 II. Data Mining 57 III. Risk-Based Explanations 58 IV. Behavioral Explanations 59 V. Structural Explanations 62 VI. Typical Investor Questions 63 VII. Conclusion 68 Part III Capturing Smart Beta Factors Chapter 4 Weighting Schemes 71 I. Introduction 73 II. Weighting Schemes Used to Capture Factor Returns 73 III. Assessing the Investment Performance and Efficiency of Weighting Schemes Used to Capture Factor Returns 82 IV. Typical Investor Questions 96 V. Conclusion 101 Chapter 5 Factor Specifications 109 I. Introduction 110 II. Value 111 III. Momentum 114 IV. Low Volatility 115 V. Quality 116 VI. Typical Investor Questions 119 VII. Conclusion 122 Chapter 6 Active Risk and Return Decomposition of Smart Beta and Active Strategies 125 I. Introduction 127 II. Risk Decomposition of Smart Beta Strategies 127 III. Risk Decomposition of Active Strategies 134 IV. Typical Investor Questions 142 V. Conclusion 148 Part IV Performance Characteristics of Smart Beta Factor Strategies Chapter 7 Performance Characteristics of Individual Smart Beta Factors 151 I. Introduction 152 II. After-Cost Performance: Accounting for Implementation Costs 154 III. After-Cost Performance Characteristics 158 IV. Typical Investor Questions 168 V. Conclusion 171 Chapter 8 Performance Characteristics of Factor Diversification Strategies 173 I. Introduction 175 II. Active Return Correlations 175 III. Performance Characteristics of Factor Diversification Strategies 179 IV. Constructing Diversification Strategies: The Portfolio Blending versus Signal Blending Debate 197 V. Typical Investor Questions 202 VI. Conclusion 209 Chapter 9 The Low-Volatility Anomaly 211 Roger G. Clarke, Research Consultant, Analytic Investors Harindra de Silva, Portfolio Manager, Analytic Investors/Wells Fargo Asset Management Steven Thorley, H. Taylor Peery Professor of Finance, Marriott School of Business, Brigham, Young University I. Introduction 211 II. Historical Manifestation of the Low-Volatility Factor 212 III. How Is “Low Volatility” Defined? 214 IV. Secondary Factors of Low-Beta Portfolios 218 V. Building a Low-Volatility Portfolio 224 VI. Publicly Available Low-Volatility ETFs 226 VII. Summary and Conclusion 226 Part V Smart Beta Implementation Chapter 10 Structuring Better Equity Portfolios: Combining Smart Beta with Smart Alpha 231 I. Introduction 232 II. Current Portfolio Structuring Practices 233 III. Portfolio Structuring: A Suggested Framework 235 IV. Typical Investor Questions 246 V. Conclusion 258 Chapter 11 Incorporating ESG with Smart Beta 261 I. Introduction 262 II. ESG Data 263 III. Incorporating ESG Strategies 264 IV. Incorporating ESG with Smart Beta 273 V. Typical Investor Questions 277 VI. Conclusion 281 Chapter 12 An Alternative to Hedge Fund Investing: A Risk-Based Approach 283 I. Introduction 283 II. Benefits of a Diversified Portfolio of Hedge Funds 286 III. Systematic Drivers of Hedge Fund Performance 296 IV. Liquid Tracking Portfolio Simulated Performance 301 V. Developments in the Hedge Fund Industry 309 VI. Conclusion 314 Part VI Asset Owner Perspectives Chapter 13 Implementing Smart Beta at CalPERS, a Conversation with Steve Carden 319 Investment Director, Global Equities, California Public Employees Retirement System Chapter 14 A Pension Fund’s Journey to Factor Investing: A Case Study 331 Hans de Ruiter, Chief Investment Offi cer, Stichting Pensioenfonds TNO; Associate Professor, Vrije Universiteit Amsterdam I. Introduction 331 II. The Case for Passive Market Cap–Weighted Strategies 332 III. Are Smart Beta Strategies the Better Alternative? 333 IV. Practical Considerations 337 V. Conclusion 341 Chapter 15 Using Smart Beta for Efficient Portfolio Management 343 Ilian Dimitrov, Head of Growth Assets, Oak Pension Asset Management Limited; Vice President, Investments, Barclays Bank UK Retirement Fund I. Introduction 343 II. Motivation and Strategy Selection 344 III. Challenges 344 IV. Product Selection 345 V. Smart Beta Allocation 347 VI. Governance, Monitoring, and Performance Benchmarking 348 VII. Conclusion 348 Part VII Consultant Perspectives Chapter 16 Smart Beta from an Asset Owner’s Perspective 351 James Price, Director, Willis Towers Watson Phil Tindall, Senior Director, Willis Towers Watson I. The Smart Beta Revolution or Evolution? 351 II. Smart Beta from the Asset Owner Perspective 356 III. Asset Owners Face New Challenges When Using Smart Beta Strategies 364 IV. Future Developments 367 V. Concluding Thoughts 371 Chapter 17 Smart Beta: The Space Between Alpha and Beta 373 Andrew Junkin, President, Wilshire Consulting Steven Foresti, Chief Investment Offi cer, Wilshire Consulting Michael Rush, Vice President, Wilshire Consulting I. Factors: The Building Blocks of Portfolios 375 II. Alpha or Beta? 375 III. Equity Factor Investing: An Example 377 IV. Performance of Key Equity Factors 377 V. Implementation of Smart Beta 379 VI. Smart Beta Case Study: A Potential Complement to Traditional Active Management 383 VII. The Pros and Cons of Smart Beta 385 VIII. Conclusion 387 Part VIII Retail Perspectives Chapter 18 Smart Beta Investing for the Masses: The Case for a Retail Offering 395 Lisa L. Huang, Head of Artifi cial Intelligence Investment Management and Planning, Fidelity Investments Petter N. Kolm, Director of the Mathematics in Finance Master’s Program and Clinical Professor, Courant Institute of Mathematical Sciences, New York University I. Introduction to Factor Investing and Smart Beta 396 II. Why Provide a Smart Beta Strategy in Today’s Retail Market? 399 III. Challenges in Developing a Smart Beta Portfolio Strategy for Retail Investors 401 IV. Implementing a Smart Beta Portfolio Strategy as a Fiduciary Advisor 402 V. A Look into the Future 407 VI. Conclusion 409 Chapter 19 Positioning Smart Beta with Retail Investors, a Conversation with Jerry Chafkin 411 Chief Investment Officer, AssetMark Part IX Concluding Remarks Chapter 20 Addressing Potential Skepticism Regarding Smart Beta 425 I. Skepticism Regarding Factor Existence 425 II. Skepticism Regarding Implementation 426 III. Skepticism Regarding Factor Persistence 429 IV. Conclusion 430 Chapter 21 Conclusion 431 About the Authors 433 Bibliography 447 Additional Disclaimers 459 Index 463