Understanding Style Premia

Targeting Value, Momentum,                                         and Other Styles

Understanding Expected Returns 

Investors tend to think of expected returns as a function of asset class risk, but this thinking may have led them to take on too much equity risk. For behavioral reasons, diversifying across investment styles, such as blending momentum and value, may offer greater returns for less risk. Limited market timing may also increase returns. 

Style Investing: The Long and the Long/Short of It 

Many investors agree that applying sys- tematic tilts away from a passive, capitalization-weighted portfolio is a good idea; fewer agree on how best to capture these style-based returns. Long-only, or “smart beta”, strategies apply tilts (typically within equities) to give exposure to styles such as value, momentum, size or low-risk – that is, they overweight stocks that are relatively cheap, have recently outperformed peers, have a small market cap, or are classified as low risk or high quality. These tilts aren’t always explicit, as some smart beta strategies emphasise a portfolio goal rather than a rule for picking securities, for example, maximum diversification or minimum volatility. However, all these approaches result in deviations from market capitalization weights that in practice imply certain systematic style tilts. 

Exploring Macroeconomic Sensitivities: How Investments Respond to Different Economic Environments 

A growing number of investors have come to view their portfolios as a collection of exposures to risk factors. “Risk-based investing” can mean different things to different inves- tors, but the common feature is the emphasis on improved risk diversification. Although many investors identify risks primarily as asset class exposures, others may look at underlying macroeconomic exposures, such as inflation sensitivity. The difficulty with the latter approach is that macroeconomic factors are not directly investable.

With this in mind, a framework is provided for investors to think about how investable return sources tend to relate to non-investable macro factors. We present empirical evidence on the sensitivity of investments (traditional long-only asset class premia and alternative long/short style premia) to macro risks (such as economic growth and inflation). 

All photography by Jared Chambers