Popular factor analysis tools might lead investors to dangerous allocation mistakes, according to smart beta index provider, ERI Scientific Beta.
Its newest study, “Measuring Factor Exposure Better to Manage Factor Allocation Better: A Critical Approach to Popular Box Initiatives”, found there were several new factor tools promoted by investment market leaders as factor risk analysis standards.
However, most of them could lead to serious misalignment between an investor’s factor diversification objectives and the measured and realised allocation.
The findings of the study indicated that:
- These analytic tools did not employ academically-grounded factors and their factor-finding process maximised the risk of ending up with false factors,
- Non-standard factors led to mismeasurement of exposures and may capture exposure to redundant factors,
- The use of factor scores instead of factor betas for the measurement factor exposures was a cause of concern,
- The major drawback factor scores suffered from “double counting” of exposures, which was due to their lack of regard for the correlation structure of factors.
