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EDHEC-Risk Institute raises concerns on smart beta


EDHEC-Risk Institute has conducted a study, produced as part of the Société Générale Prime Services (Newedge) research chair on “Advanced Modelling for Alternative Investments”.

The Institute says that the study attempts to give an overall view on alternative equity beta strategies, to determine the areas of usage and to analyse the alternative equity beta practices and perceptions of investment professionals.
Between January and February 2014, EDHEC-Risk Institute carried out a survey among a representative sample of 128 investment professionals to identify their views and uses of alternative equity beta. The study found that investors are familiar with the construction principles of advanced beta strategies, but less familiar with underlying risks and drivers of performance. According to EDHEC-Risk Institute, this lack of knowledge on risks poses a problem not only for the proper use of these alternative equity beta strategies, but also with respect to them being fairly marketed.
EDHEC-Risk reports: “Respondents allocate relatively few resources to the evaluation of alternative beta. The average respondent uses fewer than two full-time staff (1.77) to evaluate alternative beta offerings, a much lower number than that used to evaluate active managers (3.42).”
The Institute feels that this shortfall in resources is illogical given that the same respondents see bigger challenges when evaluating advanced beta offerings, than when evaluating active products.
Key challenges in the use of smart beta lie in the lack of access to data, in particular live and after-cost performance, especially as for all types of risks, respondents agree that information is not widely available from product providers.
“Respondents’ answers show that the theoretical justification of a strategy is seen as about as important as live performance, highlighting the need for product providers to focus not only on recent performance but also on the fundamental economic reasons for a strategy’s performance benefits” the report says.
Implementation is a key aspect for respondents, the study found, as they commonly use a wide array of measures to assess implementation of alternative equity beta strategies (turnover, transaction costs, etc.), implying that product providers need to carefully consider implementation in product design.
“Respondents prefer long-only strategies to gain exposure to alternative risk premia, in particular due to perceived implementation hurdles for long/short strategies and respondents require more from factor investing strategies than simply providing the right direction of exposure, notably to provide an efficient risk-adjusted return for a factor exposure, with ease of implementation.”
EDHEC-Risk concludes that while the survey results suggest that advanced beta equity investing is a promising avenue for the investment industry, results also contain a note of caution, in that there is a risk that the good idea of advanced beta equity investing may end up being compromised by practical investment challenges and perceived insufficiencies of current products, notably in the form of insufficient transparency and on the difficulties in implementing long/short strategies.

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