An Examination of Traditional Style Indices

Abstract

For investors using a core–satellite approach to strategic asset allocation, traditional style indices, such as value and smallcap indices, represent convenient passive vehicles for achieving strategic or even tactical portfolio tilts. In this article, the authors examine traditional style indices using the Fama–French three-factor analysis. They find that most of the style indices exhibit a negative Fama–French alpha and statistically conclude that traditional style indices are suboptimal means for creating style tilts in portfolios. They posit that the source of the sub-optimality comes from the capweighted construction methodology, which these indices are rooted in and demonstrate that using a simple non-priceweighted approach for creating the style indices would result in more efficient exposures.

TOPICS: Style investing, passive strategies, factor-based models, statistical methods