Betting against Quant: Examining the Factor Exposures of Thematic Indexes

Abstract

The performance characteristics of recently introduced thematic indexes are examined using standard asset pricing theory. The main finding is that thematic indexes generally exhibit strong negative exposures to the profitability and value factors, indicating that they hold growth stocks that invest now for future profitability. As such, investors in thematic indexes are effectively trading against quant investors, who prefer stocks that are currently cheap and profitable. If the negative factor exposures of thematic indexes persist, then from an asset pricing perspective this implies low expected returns. As there is clearly a clientele for thematic indexes, the author discusses how investing in these strategies may be rationalized despite their unfavorable factor exposures.