Enter the world of smart beta

Enter the world of smart beta
Http://mp.weixin.qq.com/s/4EJmt-jzY1D9cTK5eZaVow
Cross-border Investments in the 2017-06-18

Smart Beta investment strategy is a kind of way between active investment and passive investment. According to Morningstar statistics, smart beta products now account for One-fourth of the U.S. listed ETF market, starting in 2015, more than one-third of new ETF products are using smart beta strategy, using smart The scale of the beta strategy has soared from $103 billion trillion in 2008 to $616 billion at the end of 2015.

Smart Beta Party

What exactly is smart Beta. Its theoretical basis and the way to build it. Why Smart beta has grown so fast in overseas markets. This paper will discuss these issues. What is smart Beta?

In general, "Beta" represents the sensitivity of portfolio gains to market portfolio returns or other risk factors, while "Alpha" represents the ability to select stocks and timing. But "Smart beta" is different from the "beta" represented by the traditional passive index, and it will have an active exposure to some risk factors to gain excess income, because we can define it as a form of investment between active and passive investment.

The Smart Beta index can be seen as a rule-based type of investment tool. Rule-based investment, refers to the investors in advance based on investment objectives set a set of investment criteria-usually based on a rule-based or quantitative approach, optimize the stock selection and weight of the arrangement, increase the index on some risk factors exposure. When the investment criteria have been set, investors will need to build portfolios in strict accordance with the requirements of the guidelines, to obtain a lower risk and higher return than the weighted combination of market capitalisation.

Unlike index funds, which pursue close tracking of indices, "Smart Beta" obtains excess returns that outperform traditional market-weighted indices by optimizing the index's market-weighted approach. Combined with two advantages of active investment and passive investment, it can break the limit of market capitalization weighted index and provide investors with a more flexible and diversified portfolio strategy. The origins and evolution of Smart Beta

Smart Beta can be said to be the product of the development of the whole modern investment theory. Classical portfolio Theory, Capital Asset pricing Model (CAPM), Arbitrage pricing model (APT), Efficient market theory (EMH) and behavioral finance theory form the core of modern portfolio classic theory, which lays a theoretical foundation for indexation investment.

The 1960 Capital Asset pricing Model (CAPM) made the market realize that the original Alpha gain is partly a beta gain. William F. Sharpe's CAPM theory holds that the market mix provides the optimal risk-return ratio. However, in the actual investment activities, no one can hold a real "market mix", so the market capitalisation weighted composite index has become a substitute for the market mix, the return of the market composite index represents the market income. In the capital asset pricing model (CAPM), beta measures the size of the risk premium relative to holding the entire market. By establishing a linear relationship between income and risk, the CAPM model explains that any excess income above the market is derived from the premium of a particular exposure, in which beta is the linear coefficient. Market indices are usually weighted by market capitalisation, and if the market index is replaced by a non market weighted index or portfolio, the beta is smart beta.

After the 1990, the Fama-french, Carhart, and AQR (Asness, Frazzini, Israel, Moskowitz) models further defined market beta, scale beta, value beta, momentum beta, Quality beta, the continuous optimization of these models provides important theoretical support for style investment and factor investment. As long as the portfolio is selectively exposed to specific risk factors, a corresponding risk premium can be obtained, and a rule-based and transparent approach to weighting the validated risk factors is the core idea of the smart beta strategy.
The construction of Smart beta combination

STEP1: Select asset and Style module

At present, the smart beta strategy of overseas market is distributed in the major categories of assets and style attributes, and large categories of assets including stocks, interest rates, commodities, foreign exchange, etc., the excess income source style attribute can be divided into spreads (carry), value (value), momentum (momentum), others etc. When you select a large class of assets and style attributes, a corresponding policy is generated, a simple policy map is as follows:

Schwab Center's several big smart beta strategies over the years (click to see the big picture)

Step 2: Policy classification
After selecting the asset and style modules, we usually make a correlation matrix of all the strategies to observe the correlation coefficient between strategy and stock, strategy and strategy. Then through situation analysis and stress test, the stock and interest rates rise and fall to different degrees under the assumption that the price of this strategy and Sharpe ratio changes, and then the strategy is divided into offensive strategy, defensive strategy and neutral strategy.

Aggressive strategy (Risk on): Such strategies as equity value, dividends, volatility carry, FX carry, and so on, are positively correlated with the stock market, and in extreme markets the correlation will increase.

Defensive strategy (defensive): such as Equity Low vol, equity quality, rates carry, FX value, and other policies, this kind of strategy and stock relevance is very poor, in extreme market conditions, the correlation is maintained at a low level.

Neutral Strategy (Neutral): such as equity momentum, liquidity, commodities carry, cross asset, and other strategies, the market's ups and downs of the strategy has no effect, neither offensive nor show defensive.

Step 3: Combined build
There are many kinds of combinatorial construction methods, which can be divided into four categories: equal weight distribution, reciprocal volatility, risk parity and risk budget.

Equal weight distribution: Each strategy in the combination of medium weight distribution. The method is simple and transparent, but the risk distribution is unbalanced.

The reciprocal of volatility: each strategy is weighted by the reciprocal of the fluctuation rate. The method is simple, transparent, and the distribution of volatility exposure is balanced, but the numerical correctness of the volatility and the unanticipated correlation dynamic change will make the risk distribution unbalanced.

Risk parity: This method determines the weights of the policies by taking into account the same risk that each strategy contributes to the portfolio, considering both the volatility of the strategy and the correlation between the strategies. This method guarantees the equilibrium distribution of risk, but the error of volatility and correlation value will affect the accuracy of the model.

Risk budgeting: This approach is based on risk parity, based on the level of risk that can be set beforehand, assigning a preset risk value, configuring the risk to different strategies, and keeping the risk level within budget. This approach makes each strategy have a specific risk contribution to the portfolio, but as with risk parity, volatility and correlation errors can affect the accuracy of the model.

Step 4: Volatility control
If the combination requires volatility control, we will adjust the volatility at a certain frequency to achieve dynamic configuration. Before the combination of the official operation, we will first set the target volatility, the maximum volatility, the lower volatility rate and a single policy maximum allocation ratio, during the combined operation, the actual volatility will be the preset frequency of comparison with the above indicators, once the target value, it will make adjustments. Volatility control is usually implemented using leverage. The future of Smart Beta

Since the launch of the first ETF product in the United States in 1993, ETFs have grown rapidly worldwide. 2015, the global ETF market further developed, the number and size of the steady growth, ETF number reached 5,449, assets of 2.95 trillion U.S. dollars, a net increase in assets of 215.6 billion U.S. dollars. Against the backdrop of fast-growing ETFs, Smart Beta ETFs continued to be an ETF hotspot in the mature market for 2016 years, with 760 in the US market as of October 7, 2016, and 63% per cent of the market ETFs in asset size. In terms of quantity, Smart Beta ETFs have grown rapidly since the 2005 fundamentals. The number of new smart Beta ETFs was 103 in 2015.

2017 to date ETF Capital inflow classification

Source: Bloomberg

From the top 20 smart beta ETF products, smart beta ETF issuers are focused on BlackRock, Vanguard, 50%, 25%, respectively, and BlackRock, Vanguard's smart beta The number and size of ETFs are close to or even more than 20% of all their ETFs. In addition, the rate of the overall Smart Beta ETF is between the index fund and the active fund.

Source: BlackRock

The ETF products based on the Smart Beta index have the following characteristics:
Low cost, transparent rules. The Smart Beta index retains the characteristics of traditional ETF products and uses an exponential management model to manage capital. Since ETFs can be traded in the two tier market, trading efficiency is significantly higher compared with traditional equity funds and is cheaper in terms of tax and management costs.
Can better control the risk and enhance the income target. Early ETFs are weighted according to market capitalisation, the biggest advantage is to be able to replicate the market situation more accurately, the biggest disadvantage is that it is difficult to achieve excess income, and the Smart Beta Index in the compilation method, from the stock selection and weighted two aspects have been optimized, In order to obtain the excess income based on the traditional market value weighted index.
With good liquidity and transaction efficiency. Smart Beta ETFs retain the nature of ETFs that can be traded in the two tier market, with higher transaction efficiency and better liquidity than traditional stocks.

A survey of global asset managers by the FTSE Russell

According to the survey: in 2014 and 2015, managers thought that "enhanced profitability" and "risk reduction" were two major drivers of smart beta. While these two factors remain mainstream in 2016, "cost savings" is becoming the main objective of managers with assets managed at more than $10 billion trillion, while "improving diversity" is one of the main goals of managing managers with a size of less than $10 trillion.

In short, Smart beta strategy is a personalized and strong strategy to achieve specific goals to meet the needs of investors personality. Typically, asset managers use the smart beta strategy to consider two factors: one is to reduce risk and the other is to increase profitability. In addition, there are targets such as decentralization and cost savings. From the application of smart beta strategy, the current strategy has become the mainstream, asset managers will often adopt multiple smart beta strategy for asset allocation.