I didn’t realise until recently that Eugene Fama & Keneith French had extended their famous three factor model to five factors. They have added RMW, the return spread of the most profitable firms minus the least profitable stocks and CMA, the return spread of firms that invest conservatively minus aggressively to the standard size spread SMB and value spread of HML. You can find a piece discussing it in a Forbes article.
Following on from the five factor model there is an interesting piece on the AQR website at the end of last year which considers extending the five factor model to six, by adding in UMD, momentum winners and losers. It’s is well worth a read.
Everybody seems to be looking at smart beta these days, particularly within the equity space as an alternative to pure passive. I’m not a great fan of the term smart beta, as if your definition is ‘a non free float cap weighted index’ then price weighted indices such as the Dow 30 and Nikkei 225 are smart beta. Alternative indexation is a better term, but a bit of a mouthful.
Given cap weighted indices by their very nature have a fairly low turnover, a big issue with smart beta is the difference between a smart beta benchmark as calculated by an index provider that everyone looks at and a real world portfolio implementation of that benchmark, which may have a very significant two way turnover when rebalanced. Take for example a minimum variance portfolio, which can have a very significant turnover. The problem becomes progressively worse as the investable universe becomes less liquid, as transaction costs increase and as more non major fx’s are involved. An example of this is the potentially significant difference between benchmark performance and the implementation drag of say an S&P 500 minimum variance portfolio and a minimum variance broad emerging markets portfolio.