FRM Part II · FRM Exam Part II · Factors
A fund manager markets a minimum-variance smart beta strategy. Compared with its cap-weighted parent index, which feature should a risk manager expect?
A minimum-variance strategy typically gains exposure to the low-volatility anomaly, with lower beta, defensive sector tilts and possible concentration. It will show tracking error against the cap-weighted parent index rather than matching it, and it does not overweight high-volatility stocks.
- AHigher market beta, because it overweights high-volatility stocks
- BExposure to the low-volatility anomaly, with a tendency toward defensive sectors and possible concentrationCorrect
- CReturns that are perfectly correlated with the parent index
- DZero tracking error versus the parent index
Explanation
Minimum-variance optimization favors low-volatility, low-beta stocks, which captures the low-risk anomaly but often concentrates in defensive sectors and can create meaningful tracking error. Beta is typically below one, not above, and correlation with the parent is not perfect.
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