The Impact Of Risk Controls And Strategy-Specific Risk Diversification On Extreme Risk

To overcome the deficiencies of cap-weighted indices, smart beta strategies have been proposed. They employ weighting schemes that deviate from cap-weighting, deal with the problem of concentration and allow for a flexible index construction process in which the index can be tilted to better rewarded factors. Along with the better risk-adjusted performance, however, investors in smart beta strategies are exposed to additional risks.The goal of this paper is to check empirically if controlling the exposure to some risks such as country, sector, tracking error, or sample risk does not increase the exposure to other types of risk, such as tail risk, that may remain unaccounted for by the index construction process.