The Latest Wave in Advanced Beta: Combining Value, Low Volatility, and Quality

Abstract

The latest wave in advanced beta, also known as smart beta, factor investing, and risk premia investing, among other names, has focused on combining multiple factors in one portfolio. One of the more widely discussed combinations has been Value, Low Volatility, and Quality, which results in a portfolio with lower than average valuation and return volatility, and higher than average quality (measured by metrics like profitability, earnings variability, and leverage). In this paper, we discuss why this combination has been of interest and summarize the key considerations for investing in such a strategy. Both the intuition behind the three factors as well as the empirical evidence has have provided support for the combination. Moreover, the three-factor portfolio takes advantage of strong diversification benefits over time which dampens the well-known challenge of cyclicality in advanced beta strategies, a key hurdle in implementation.