A new publication from ERI Scientific Beta, the index arm of EDHEC Risk Institute, entitled “Robustness of Smart Beta Strategies,” reviews the importance of robustness for smart beta strategies.
The paper also explains various methods by which smart beta strategies try to improve robustness, and discusses how to measure and assess robustness when analysing the performance of smart beta strategies.
ERI Scientific Beta underlines the importance of trusting academic consensus at a time when the number of factors available is increasingly rapidly. The good idea of factor investing should not be transformed into factor fishing and data mining.
The study shows that there is no positive and statistically significant long-term risk premium for a “value” factor definition that relies on the approach termed “fundamental,” even though this approach is highly popular with investors and index providers. ERI Scientific Beta recommends that investors stick tightly to academic consensus in the area of factor definition.
The study stresses the importance of measuring robustness correctly. The measurement relies on the transparency of track records and the availability of instruments to measure robustness, such as the probability of outperformance. The probability of outperformance enables the smart beta index’s capacity to outperform to be measured for a chosen investment duration, whatever the investment period.
This probability of outperformance measure allows one to observe that not alone are smart beta indices different in terms of risk-adjusted performance, they are not all equal in terms of robustness either. It confirms the quality of indices produced with state-of-the-art academic research, such as the Scientific Beta indices produced by EDHEC-Risk Institute, whether involving the definition of the factors or the implementation of diversification techniques to obtain high-performance proxies for factors that are rewarded over the long term.
