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A Systematic Approach
By Paul Amery | 24 February, 2012   

Paul Amery

The growing interest in factor indexing is a sign of a broader revolution in the asset management business.

Hedge fund managers, those providers of expensive "alpha", lost money for their clients in 2011 in aggregate, just as they did in 2008. Their portfolios, marketed as capable of providing positive returns in all conditions, turned out to be much more exposed to the equity markets' fortunes than advertised.

Increasingly, investors have realised, market returns can be broken down into a series of systematic exposures, or factors, which can then be reproduced at much cheaper cost than via a typical hedge fund's "two and twenty" fee.

The ideas behind factor investing are not new. There has been steady interest in the subject since Eugene Fama and Kenneth French published a key research paper nearly 20 years ago. However, there's a vibrant, ongoing debate on the best way to put together factor indices.

And, prompted by growing dissatisfaction with the general cost of fund management services after a decade of low or negative returns from most equity markets, there's now an increasing urgency to offer cheap, investable, factor-based portfolios to investors.

In this issue, representatives of four leading index firms offer an excellent overview of factor indexing. There's particular emphasis on some of the apparent anomalies that research in this area has thrown up: why, for example, value-weighted and low-risk strategies appear to outperform the broader market on a consistent basis.

In a comprehensive overview of the subject, Xiaowei Kang of Standard & Poor's starts from first principles in defining and then categorising a range of "alternative beta" strategies. Barry Feldman and Gareth Parker of Russell Indexes look at how portfolios can be put together to offer a "tilt" towards momentum, volatility and beta, while also proposing a framework for long-short index strategies involving factors.

In the third of our articles, Chin Ping Chia and Dimitris Melas of MSCI examine risk-based indexing in detail, looking at alternative methods of capturing the low-volatility effect. Finally, Anthony Lazanas and Arne Staal of Barclays Capital extend a factor-based approach beyond equities, presenting a range of asset classes and seeking to isolate and characterise the most important types of risk premium.

I hope that this issue of the Journal of Indexes Europe will be of interest to a wide range of investors.

 

Sign Paul Amery

Paul Amery
Editor

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