Towards Second Generation Equity Risk Based Strategies
32 Pages Posted:
Date Written: August 26, 2012
In this paper we discuss some well-known smart beta strategies like minimum variance, maximum diversification and different forms of risk parity (equal risk budget and equal risk contribution), which we call first generation smart beta. We show that their risk and returns result from exposures to factors such as low risk and size, in particular. However, we highlight a number of issues with these first generation approaches and propose that more efficient second generation smart beta strategies should focus on targeting the desired factor exposures and minimising unwanted risk exposures, e.g. sectors, rather than just on algorithms for portfolio allocation. We give an example of a smart beta low risk strategy that more efficiently captures the low risk factor premium than those above.
Keywords: Low Volatility, Low Risk Anomaly, Minimum Variance, Minimum Volatility, Factor Investing, Equities, Smart Beta, Sectors
JEL Classification: G11, G12, G14, E44
Suggested Citation: Suggested Citation