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ActiveBeta Indexes: Capturing Systematic Sources of Active Equity Returns

ISBN: 978-0-470-61002-2
215 pages
March 2010
ActiveBeta Indexes: Capturing Systematic Sources of Active Equity Returns (0470610026) cover image
An informative guide offering new and innovative ways to think about active management and investing

ActiveBeta Indexes presents exciting new research that shows how above-market returns can be achieved in a low-cost, transparent, and efficient fashion. Active Betas reflect fundamental investment principles that have long been the foundation of active equity returns, but are commonly masqueraded as investment skill, or alpha. This groundbreaking book lifts the veil to uncover the common sources of active returns and reveals their beta-like properties.

Developed by leading investment practitioners at Westpeak Global Advisors, ActiveBeta Indexes introduces Active Beta sources and explains how the behavior of short- and long-term earnings growth gives rise to systematic sources of active equity returns.

  • Details a new index framework and research findings that could change the face of active portfolio management
  • Presents patent-pending innovations for constructing style indexes and informationally-efficient active portfolios
  • Explores the historical performance of ActiveBeta Indexes

Wealth advisers, consultants, pensions and endowments, and other institutional investors will find the intellectual honesty of ActiveBeta Indexes a refreshing perspective on the active management industry. They will also find it a useful guide to a more strategic allocation of their risk and management fee budgets – a growing necessity in these challenging times.

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Foreword by Andrew W. Lo xi

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

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Khalid Ghayur is the CEO and CIO of Westpeak Global Advisors, LP. He was director of research policy, a member of the Global Executive Committee, and chairman of the Index Policy Committee at Morgan Stanley Capital International (MSCI) Barra. Prior to this, he was global head of quantitative research and strategy for HSBC Global Asset Management. He is a CFA charterholder, has served on the Board of Governors of the CFA Institute, and is a former trustee of the CFA Institute Research Foundation. He received an MBA in finance and international business from the Ecole Nationale des Ponts et Chaussees and an MA and BA in economics from the University of Karachi.

Ronan G. Heaney is Director of Research at Westpeak. Before joining Westpeak, he was a software architect with Multum Information Services and a senior software developer at Swiss Bank Corp. He holds an MS in computer science from Purdue University and a BS in applied physics from Dublin City University, Ireland.

Stephen A. Komon is a Senior Portfolio Manager at Westpeak. Prior to this, he was vice president of foreign exchange and commodities at J.P. Morgan & Co., and he also held positions with UBS AG/Swiss Bank and Dean Witter Reynolds. He holds an MBA in finance and accounting from the University of Chicago Booth School of Business and a BS in commerce from the University of Virginia. He is also a CFA charterholder.

Stephen C. Platt is Director of Portfolio Management at Westpeak. Before joining Westpeak, he cofounded and was a senior vice president of Cordillera Asset Management. He holds a BS in finance from the University of Colorado Leeds School of Business and is a CFA charterholder.

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