ActiveBeta Indexes: Capturing Systematic Sources of Active Equity Returns

Preface xiii

SECTION ONE Background

CHAPTER 1 The Evolution of Market Indexes and Index Funds 3

The Early Days of Indexing 3

The Inception of the Mutual Fund Industry 5

Enter Academia 6

The Advent of Index/Passive Mutual Funds 7

Index Mutual Funds for the Public 8

Conclusion 9

CHAPTER 2 The Evolution of Equity Style Indexes 11

Empirical Challenges to Financial Theories 11

Theoretical Explanations of Anomalies 13

Establishing Equity Styles 14

Equity Style Index Methodology 16

Pitfalls of Current Equity Style Indexes 17

Conclusion 17

SECTION TWO ActiveBeta Conceptual Framework

CHAPTER 3 Introducing Active Betas 21

Defining Active Betas 21

Identifying the Drivers of Equity Returns 24

Verification 26

Exploring the Behavior of Return Drivers 28

CHAPTER 4 Behavior of Short-Term Earnings Expectation and the Link with Price Momentum 29

Analysis Methodology 29

Relationships Studied 31

Decomposing Momentum Returns 48

Conclusion 51

Appendix: Regression Analysis and Correlation Coefficient 51

CHAPTER 5 Behavior of Long-Term Earnings Expectation and the Link with Value 53

Relationships Studied 53

Investment Horizon of Value Strategies 70

Implications for Stock Risk Premium 74

Decomposing Value Returns 76

Conclusion 79

CHAPTER 6 Pricing and Persistence of Systematic Sources of Active Equity Returns 81

Pricing of the Systematic Sources of Active Equity Returns 81

Persistence of the Systematic Sources of Active Equity Returns 89

Momentum, Value, and Risk Aversion 94

ActiveBeta Framework: A Summary of Relationships 99

SECTION THREE ActiveBeta Indexes

CHAPTER 7 ActiveBeta Index Construction Methodology 103

Investment Process Indexes 104

Objectives of Investment Process Indexes 105

Conflicting Objectives 108

Transparency, Understanding, and Rationale of the ActiveBeta Momentum Index 110

ActiveBeta Index Construction Process 110

Differences in Construction between ActiveBeta Indexes and Other Public Style Indexes 112

Achieving Objectives 114

Conclusion 120

Appendix: ActiveBeta Index Construction Process Example 120

CHAPTER 8 Historical Performance of ActiveBeta Indexes 123

ActiveBeta Index Construction Process Overview 123

ActiveBeta Index Performance: Highlights 126

ActiveBeta Index Performance: Detailed Analysis 127

ActiveBeta Index Exposures 149

Conclusion 153

CHAPTER 9 ActiveBeta Index Applications 155

Style Investing: A New Framework 155

Performance Attribution: Decomposing Active Manager Returns 160

Portfolio Structuring: Revisiting the Alpha-Beta Return Separation 164

Performance Benchmarking 169

Research and Analysis 172

Investment Vehicles 174

SECTION FOUR ActiveBeta Customizable Solutions

CHAPTER 10 Alternative Solutions for Capturing Active Betas 179

ActiveBeta Custom Indexes 179

ActiveBeta Custom Solutions 183

A Word on Traditional Active Management 194

Conclusion 197

CHAPTER 11 Concluding Remarks 199

Disclosures 201

Bibliography 203

About the Authors 207

Index 209