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Smart beta risks can be controlled while benefitting from performance, says EDHEC-Risk

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It is possible to reconcile the performance of smart beta with control over the risk of the investment, according to a publication from the Amundi ETF & Indexing research chair at EDHEC-Risk Institute.

The report begins with the observation that if the performance of smart beta comes from efficient allocation to smart factor indices maximising the risk-adjusted performance for a given factor exposure, the implementation of a risk allocation solution to support this efficient allocation to smart beta enables the risk constraints to be respected in both absolute and relative terms.
 
In relative terms, it is possible to sharply reduce the tracking error and the relative drawdown of the smart beta investment with robust risk allocation techniques in a portfolio of smart beta indices. As such, a Relative Equal Risk Contribution (ERC) or Relative Global Minimum Variance (GMV) approach for a developed world universe gives tracking error of around 2.5 per cent with relative drawdown of five per cent.
 
In absolute terms and as part of a long-only allocation, even though investable smart beta indices are never pure in the long-only space, it is possible to respect factor risk parity constraints. This result means that it is not necessary to turn to long/short or highly concentrated factor indices that present investability problems and are particularly poorly diversified when reaching objectives on controlled exposure to risk factors.
 
Noël Amenc, director of EDHEC-Risk Institute and CEO of ERI Scientific Beta, says: “For EDHEC-Risk Institute, the challenge with smart beta investing today is not only to avail of smart factor indices with good risk-adjusted performance but also to allocate to these smart factor indices in a risk-efficient way. This new publication shows how this can be done.”
 
Valérie Baudson, global head of ETF & Indexing at Amundi, says: “Institutional investors are showing growing interest in, and increasingly using, smart beta, which is definitely a strategic axis of development for Amundi. We are delighted to support EDHEC-Risk Institute, which, with this new research paper, provides additional guidance for investors to optimise the implementation of smart beta strategies in their asset allocation.”

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