Factor investing has gained popularity in recent years and large asset flows have been recorded into so-called smart beta and risk premia themed products, often viewed as a robust, transparent, and economical alternative to passive index strategies and active management alike. The increasing prominence of this class of strategies has raised the question of how much capacity they can accommodate and whether these portfolios can remain liquid and tradeable amid sustained inflows while maintaining their claims of outperformance.
Using a comprehensive set of global “smart beta” exchange-traded funds (ETFs), in conjunction with factor risk premia and transaction cost estimates from Axioma Factor Risk Models, we find that the market of smart beta strategies capturing equity factors has room to grow, and rebalancing costs are not expected to exceed factor premia for some time.