iSTOXX Europe Factor Indices – Harvesting Equity Returns With Bond-Like Volatility
Jun. 20, 2017
Speaker : Dr. Jan-Carl Plagge , Head of Applied Research & William Summer, Quantitative Research Analyst, STOXX Ltd.
The iSTOXX Europe Market Neutral Single and Multi-Factor Indices developed by STOXX in collaboration with Alpha Centauri offers investors a unique and very innovative way to target and capture premia of six well-documented sources of systematic risk: value, carry, momentum, size, low risk as well as quality.
Based upon the long only iSTOXX Europe Factor indices, which provide investors with a broad market exposure plus a factor tilt, the market neutral indices are constructed by beta hedging the factor index with one of Europe’s most liquid benchmark index, the STOXX Europe 600. Due to its innovative construction, these market neural indices distill the respective equity factor premia, mostly undisturbed by systematic sources of risk, into an investable index, hereby neutralizing market directionality and volatility. Hence, investors can capture pure returns associated with targeted factors without the need to “drag along” a broad market exposure.
Comparably low volatility levels around five percent make market neutral factor indices an interesting investment vehicle also for risk-averse investors, who traditionally might only consider fixed income products. Further, very low correlations between market neutral factor returns and the market itself enables investors to build better diversified portfolios with superior risk-return characteristics. The increased diversification can decrease sensitivities to common market risk factors (such as interest rate risk for bond portfolios).
The empirical results show that all iSTOXX Europe Market Neutral Single Factor Indices provide significant excess returns relative to their benchmark over our sample period of twelve years. With correlations to the benchmark index STOXX Europe 600 ranging from a minimum of -0.62 (low risk factor) to a maximum of 0.06 (value factor), factor returns are found to also serve as a great source of diversification when used in addition to an existing investment in a broad European benchmark index such as the STOXX Europe 600. Low correlations among factor returns further add to the diversification potential when investing in more than just one factor index.
However, risk premia are found to vary over time. This observation as well as the low correlation among factor returns provide the grounds for the construction of the iSTOXX Europe Market Neutral Multi-Factor index. Its innovative methodology leads to higher returns compared to a heuristic, e.g. equally weighted aggregation of single factor indices.
 Alpha Centauri is an independent multi-asset management boutique founded in 2005 and based in Hamburg, Germany. It is an investment manager specialized in innovative liquid alternative products, with factor investing at the core of its business. www.alpha-centauri.com.
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