Capacity of Smart Beta Strategies from a Transaction Cost Perspective

Abstract

Using a transaction cost model and an assumption for the smart beta premium observed in data, the authors estimate the capacity of a particular implementation of momentum, quality, value, size, minimum volatility, and a multifactor combination. For a given trading horizon, they can find the fund size at which the transaction costs from flows into these strategies negate the smart beta premium. For a one-day trading horizon, momentum is the strategy with the smallest assets under management (AUM) capacity of $65 billion, and size is the largest with an AUM capacity of $5 trillion. At five days, momentum and size capacity rise to $320 billion and over $10 trillion, respectively.

TOPICS: Factor-based models, performance measurement