Smarter Beta Investing: More Focus, Less Sustainability Bias, Same Performance

Abstract

This study demonstrates how smart beta indices, tilted towards Size, Quality, Value, and other factors, can be replicated, and customized to address inherent negative sustainability biases while

maintaining the Sharpe ratio. The core MSCI World Factor Tilt indices are replicated and analyzed. The findings highlight the lack of pronounced factor tilts for the ESG, Size, and Quality factors in

the MSCI Indices, while the replicated style indices exhibit pronounced tilts across all styles. A sustainability analysis of the benchmarked factor portfolios reveals a high negative sustainability

bias with significant variations in emissions and climate transition. For instance, emissions for the Value replication increased by about 75% compared to the World benchmark. Customizing the

style index replications by reducing the number of constituents and increasing the target tilt by 50% amplifies the negative sustainability bias, notably more than doubling Value's emissions

compared with the World benchmark. However, integrating sustainable constraints effectively mitigates these negative biases across the eight factor-tilt portfolios while preserving their target

tilts and Sharpe ratios. This approach allows practitioners to implement new or maintain proven factor-based investing strategies, sharpen their tilts, and meet evolving sustainable regulations by

correcting negative sustainability biases – all while maintaining performance.

Keywords: Replicable and Enhanced Factor Tilts. MSCI factor tilt indices can be closely replicated and improved using transparent portfolio construction methods., Uncontrolled Sustainability Bias. These indices exhibit a negative sustainability bias that is not explicitly addressed in their construction., Bias Mitigation without Performance Loss. The sustainability bias can be mitigated through optimization – preserving factor tilts and Sharpe ratio – enabling investors to maintain their familiar factor approach while aligning with evolving regulation or board- level sustainability preferences.

JEL Classification: G11, G12, G14, G15, G24, C38, C61, M14, Q56