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The Journal of Portfolio Management

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Article

Towards Smart Equity Factor Indices:
Harvesting Risk Premia without Taking Unrewarded Risks

Noël Amenc, Felix Goltz, Ashish Lodh and Lionel Martellini
The Journal of Portfolio Management Summer 2014, 40 (4) 106-122; DOI: https://doi.org/10.3905/jpm.2014.40.4.106
Noël Amenc
is a professor of finance and director of the EDHEC Risk Institute, as well as CEO of ERI Scientific Beta in Singapore.
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  • For correspondence: noel.amenc@scientificbeta.com
Felix Goltz
is head of applied research at the EDHEC Risk Institute and research director of ERI Scientific Beta in Singapore.
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  • For correspondence: felix.goltz@scientificbeta.com
Ashish Lodh
is a senior quantitative analyst at ERI Scientific Beta in Singapore.
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  • For correspondence: ashish.lodh@scientificbeta.com
Lionel Martellini
is a professor of finance and scientific director of the EDHEC Risk Institute, as well as scientific advisor at ERI Scientific Beta in Singapore.
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  • For correspondence: lionel.martellini@edhec.edu
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Abstract

This article argues that current smart-beta investment approaches provide only a partial answer to the main shortcomings of capitalization-weighted indices and develops a new approach to equity investing, which the authors refer to as smart-factor investing. The authors then provide an assessment of the benefits of simultaneously addressing the two main problems of cap-weighted indices—their undesirable factor exposures and their heavy concentration—by constructing factor indices that explicitly seek exposures to rewarded risk factors, while diversifying away unrewarded risks. The results suggest that such smart-factor indices lead to considerable improvements in risk-adjusted performance. For long-term U.S. data, smart-factor indices for a range of different factor tilts consistently outperform cap-weighted, factor-tilted indices. Compared with the broad cap-weighted index, smart-factor indices roughly double the risk-adjusted return (Sharpe ratio). Outperformance of such indices persists at levels ranging from 2.92% to 4.46% annually, even when assuming unrealistically high transaction costs. Moreover, by providing explicit tilts to consensual factors, such indices improve upon many current smart-beta offerings where, more often than not, factor tilts exist as unintended consequences of ad hoc methodologies.

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The Journal of Portfolio Management: 40 (4)
The Journal of Portfolio Management
Vol. 40, Issue 4
Summer 2014
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Towards Smart Equity Factor Indices:
Harvesting Risk Premia without Taking Unrewarded Risks
Noël Amenc, Felix Goltz, Ashish Lodh, Lionel Martellini
The Journal of Portfolio Management Jul 2014, 40 (4) 106-122; DOI: 10.3905/jpm.2014.40.4.106

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Towards Smart Equity Factor Indices:
Harvesting Risk Premia without Taking Unrewarded Risks
Noël Amenc, Felix Goltz, Ashish Lodh, Lionel Martellini
The Journal of Portfolio Management Jul 2014, 40 (4) 106-122; DOI: 10.3905/jpm.2014.40.4.106
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  • Article
    • Abstract
    • IDENTIFICATION OF A SUITABLE SET OF LONG-TERM REWARDED FACTORS
    • SMART-FACTOR INDICES: TURNING RISK INTO A CHOICE, RATHER THAN A FATE
    • ASSESSING ROBUSTNESS
    • CONCLUSIONS
    • APPENDIX A
    • ENDNOTES
    • REFERENCES
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  • Investors Care about the Purity of Factor Indexes: A Reply
  • Smart Beta Is Not Monkey Business
  • Diversified or Concentrated Factor Tilts?
  • How to Choose a Strategic Multifactor Equity Portfolio?
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  • Editor’s Introduction for 2021 Special Issue on Factor Investing
  • PERSPECTIVES: Plato or Aristotle: Who Got It Right? Evidence from the Equity Markets
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