Is factor investing still working?

2 responses to “Is factor investing still working?”

1. 

   ceo@scientificbeta.com

   September 24, 2019

   Dear anonymous commentator,

   Your message unfortunately illustrates our introductory point on the lack of attention of many commentators to investment matters and the wrong conclusions drawn from partial or one-sided observations.

   Before replying to you on the substance, I would like to reply on the form of your conclusion. Contrary to what you have stated, the point of our article is not to present reality from the angle that suits us, but to return to that reality. If we did not make explicit reference to our multi-factor indices to speak about factor performance, it is simply because we think that contributions to a website such as Top 1000 Funds that is a reference for investors should remain essentially, if not scientific, then at least neutral from a commercial point of view. The research article that served as a reference for our contribution analyses the conditional performances of factors that are commonly defined in the academic literature and the construction method advocated for building long-only proxies for these multi-factors is also fairly common. We chose to communicate on these proxies to illustrate a simple point, which was that it was the conditionality of the factors, and not so much the factors themselves, that was the cause of performance that we qualified as disappointing over the last three years.

   As you have been able to observe, since you refer to a document published on our website and distributed widely to the press, we always communicate in a detailed manner on the performance of our indices and we have nothing to hide. Accusing us of lacking transparency while referring to one of our published documents to do so is, to say the least, fairly inconsistent in terms of the form.

   On the substance, since our article relates to the poor performance of factor strategies over three years, we would have liked there to have been at least a reference to what we wrote, and if there were comparisons to be made, perhaps use this same three-year period.

   As you know, measurement of returns is unfortunately highly sample-dependent and choosing very short periods of six months only amplifies the phenomenon. This poor statistical representation should at least lead commentators to avoid drawing overly hasty and definitive conclusions on performance observed over short periods, especially when the justification for the usefulness of the strategies involved is that they collect factor premia, which are long-term premia.

   As far as the USD48bn (as of June 30) invested in our indices is concerned, it is essentially in multi-factor indices. As we show in the abovementioned study, this factor diversification provided positive average performance over three years for the six factors in which our long-only multi-factor indices are invested. Nonetheless, and we think it is an advantage of our construction method compared to many other competing methods that do not allow this risk to be controlled, we observe a strong difference in performance over the last three years between our multi-factor indices that benefit from market-beta neutrality in long-only (market beta 1) and those that do not benefit from it. Scientific Beta offers this fiduciary choice to investors who can thereby choose the market conditionality of their factor investment strategies. De facto, in the context of a strong bull market and in our clients’ main investment regions (US, Developed ex-US and Eurozone), the Scientific Beta indices that benefit from the market beta adjustment (CAPM Beta 1) have performed positively compared to the cap-weighted index over the past three years.

   Moreover, since you seem to be concerned about our indices’ investability conditions, the same document to which you refer provides the live performance of our indices in the main investment regions (Table 2a, page 6) and it is easy to observe therefore that in real investment conditions, whatever the variants of our indices and the risk options chosen, these indices have also largely outperformed the reference cap-weighted indices. Like you, we like facts, but it is necessary to refer to them when one wants to speak of “real investment” in our indices.

   Finally, concerning the Sharpe ratio, we do not believe that Sharpe ratio objectives of 1 or greater than 1 are realistic in the long-only space. What we know is that over the long-term, as expressed in the document to which you refer (Table 2c, page 9), the Sharpe ratio of our multi-factor strategies has been 57% greater than that of the reference cap-weighted indices.

   Noël Amenc, CEO, Scientific Beta

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2. 

   primail@ozemail.com.au

   September 23, 2019

   The most ‘remotely serious investigation’ for investors – and the only one of any relevance – is how do the real investments deliver in terms of returns and risks.

   A simple look at the performance tables for Scientific Beta’s indexes (on which USD 43 Billion of assets are replicated – i.e. managed) is illuminating.

   Scientific Beta’s Smart Beta Index Performance Report to June 2019 can be found at:

   https://ml-eu.globenewswire.com/Resource/Download/4701aef5-043b-42fa-b33e-9b1fb8d27191

   In short, every single strategy (Index) in every single market, underperformed the Cap Weighted indexes in the year to June 2019.

   Every strategy also has Sharpe ratios over longer periods of less than 1, which suggests that they are not a particularly effective use of the risk budget.

   The question is not whether Factors / Smart Beta’s / Risk Premia / etc., delivers returns – yes of course they do

   The question is whether they deliver them in a manner useful for investors, and consistent with the way that they have been included into portfolios (i.e. sold to Trustees).

   The simple reality is that Risk Premia strategies do not meet that ‘investability threshold’ in general, and in recent years have failed to delivered the easily and consistently available return premia that was sold as being just lying around waiting to be ‘harvested’ by all these ‘smart’ strategies.

   In reality markets do not give away free lunches, and the purveyors of the fallacy that they do need to adjust to that reality, rather than trying to bend reality to fit with their preferences.

   John

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