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Factor Investing: the importance of academic validation

Factor Investing and Academic Research

The growing adoption of factor investing strategies is backed by copious academic research. However, leading practitioners have expressed concern at the "zoo" of factors proposed and the adoption of factors where there is less of an academic consensus. Does the use of less common factors represent an alpha "edge" or is there a real risk of adopting spurious factors, which are not well-grounded in academic research and which won't work out-of-sample?

Below we list recent papers which tackle this topic, together with a roundup of some of the best factor investing papers from the last couple of months.

factor power

Risks of Deviating from Academically-Validated Factors (Scientific Beta, 2019)

The definitions of factors used by index providers can differ from the academic community. This 34-page paper discusses these differences and the risk for investors in adopting incorrect exposures.

What Is a Factor? The Impact of the Long-Only Constraint (Axioma, 2019)

This is part 2 of Axioma's popular series on “What Is a Factor?” Many investors are not permitted to "short" stocks, but are measured against “factors” that can go short. This paper examines the impact of that long-only constraint.

Media spotlight does not drive the Volatility effect in equities (Robeco, 2019)

Robeco investigates the effect that media coverage has on stocks' risk adjusted returns and whether media coverage is responsible for the low volatility effect. The study is based on data from 2001-2018.

A Census of the Factor Zoo (Campbell R Harvey, 2019)

This academic paper documents more than 400 factors published in top academic journals and argues that many of these factors must be spurious. The author suggests that where strategies do not have a robust academic grounding, investors expectations of excess return will be too high and the live trading experience may be disappointing.

Global Factor Premiums (Robeco, 2019)

Robeco examines 24 global factor premiums across a variety of asset classes and using over 200 years of data. Focusing on a relatively small number of factors for each asset class, the new evidence shows that the large majority of these key, global factors are strongly present under conservative p-hacking considerations, with limited out-of-sample decay of the return premia.

Smart Beta Strategies: A Main Driver of ETF Demand (BlackRock, 2019)

For compliance reasons, this paper is only accessible in the United States

This short paper from Greenwich Associates, in conjunction with Blackrock, describes how factor investing continues to rise in popularity, based on a survey of 181 participating firms.

Estimating Transaction Costs for Smart Beta Strategies (Scientific Beta, 2019)

In this 59-page report, Scientific Beta compute transaction costs and net performance of investable smart beta indices versus the conventional passive index baskets .

Smart Beta 2019 - Global Survey Findings from Asset Owners (FTSE Russell, 2019)

FTSE Russell's sixth annual Smart Beta report reveals the results and implications of a survey of 178 asset owners, across a range of AUMs and organisation types, to understand better their approach to so-called "smart beta".

Factors in Focus: Dynamic short term, strategic long term (MSCI blog, 2019)

In this short article, MCSI takes a look at global factor performance in Q2 2019 and how their adaptive multi-factor allocation model is shaping up for Q3.

ETFs in Insurance General Accounts (S&P Dow Jones Indices, 2019)

S&P Dow Jones analyses ETF usage over time in different types of insurance firms, examining the forces at work and current use of ETFs by over 1900 companies in this market.

Adding Value with Factor Indices: Design and Risk-Control (Scientific Beta, 2019)

What are the key principles for the design of a risk factor strategy? Scientific Beta discusses how to achieve robust exposure to risk factors that will generate long-term performance, how to diversify "unrewarded" risk, and the importance of high "investability". In addition to gaining exposure to long-term rewarded risks, investors should consider hidden risks that may be implicit within such a strategy.

Factor Investing: An Academic Source of Excess Returns (Savvy Investor, 2018)

This introduction to factor investing explains the academic underpinning to factor strategies, discussing the consensus that has been built around research suggesting that 4-6 equity risk factors can generate long-term excess returns. The report provides links to key academic research and practitioner papers, and describes the different risk factors being deployed by 8 of the largest asset managers and smart beta index creators.

S&P GIVI® Japan and Major Single Factors Q2 2019 Review (S&P Dow Jones Indices)

This paper examines returns from five risk factors for Japanese equities: namely Value, Momentum, Low Vol, Quality and a Buyback factor.

Factor Investing in Fixed-Income (EDHEC-Risk Institute, 2019)

EDHEC has released two recent papers on factor investing in sovereign fixed income markets. The first examines time-series momentum and the second looks at how to define and exploit value.

Factor Investing in Currency Markets: Does It Make Sense? (Amundi AM, 2019)

For compliance reasons, this paper is NOT accessible in the United States

Can factor models be made to work in currency markets? This in-depth working paper discusses standard theoretical models and the Fama French-Carhart risk factor model for the management of FX portfolios.

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