ERI Scientific Beta, the smart beta index provider, has launched a long/short equity market neutral index, the Scientific Beta Developed Multi-Beta Multi-Strategy Managed Volatility L/S Equity Market Neutral Index (x3.5).
The objective of the index is to seek exposure to long-term rewarded factors and a reduction in non-rewarded risks, which associates the factor exposure with good risk-adjusted performance, while at the same time aiming for perfect market neutrality within a universe of large and mid-capitalisation companies from developed countries. The allocation across smart factor indices is implemented with the goal of minimising the volatility of the long/short spread. Return amplification is obtained by the use of 3.5x leverage, maintaining volatility below 8 per cent.
While long/short multi-factor strategies will, by construction, harvest long-term factor premia, such strategies may expose investors to unintended risks due to poor diversification. This risk is all the greater in that long/short strategy providers seek to maximise each factor’s spread through in-sample optimisations that lack robustness, because the selected factor champions are not persistent out of sample. This factor concentration also leads to highly unstable market beta, because the factors naturally exhibit high levels of beta conditionality.
Professor Noël Amenc, CEO of ERI Scientific Beta, says: “Scientific Beta’s long/short offering corresponds to its investment philosophy: risk management, factor diversification and top-down implementation. The portfolio construction methodology prioritises risk management, which guarantees the robustness of out-of-sample performance. It diversifies across multiple factors to benefit from low correlations across factors rather than concentration in factor champions, which lack consistency and are a source of unstable performance and high turnover. The long/short solution is implemented in a top-down manner to allow dynamic allocation across factors, guarantee transparency and facilitate the search for market beta neutrality.”
Scientific Beta implements its long/short strategy through a short position in the cap-weighted reference index and a quarterly allocation to sub-portfolios in the long leg with the objective of minimising the volatility of the long/short spread under the constraint of factor exposure positivity, diversification across factor indices and market beta neutrality. The long leg sub-portfolios are designed to efficiently capture the long-run factor risk premia that have been documented as being associated with factor tilts (value, momentum, low volatility, high profitability, and low investment).
