Smart Beta Efficiency versus Investability: Introducing the Cost-Adjusted Factor Efficiency Ratio

Abstract

Increasing factor exposure is generally desirable, ceteris paribus, but it often comes at a cost; those costs may include expenses arising from more regular rebalancing or purchasing less liquid stocks. For this reason, there is a necessary trade-off between increasing exposure and greater investability. In this article, the author focuses on the financial trade-off between achieving greater targeted exposure and ensuring investability. To this end, he introduces a new smart beta metric—the cost-adjusted factor efficiency ratio—as an adaptation to the metric Hunstad and Dekhayser proposed in order to acknowledge such a trade-off.

TOPICS: Factor-based models, performance measurement