Beyond Traditional Beta 032015

March 2015
Marketing Material
For Professional Investors Only
Beyond Traditional Beta
Deutsche Bank AG
Deutsche Asset
& Wealth Management
db X-trackers ETF Team
Winchester House
1 Great Winchester Street
London EC2N 2DB
United Kingdom
1. Introduction
As a growing number of financial indices are developed to offer
exposure to investment strategies in a systematic way, investors
are confronted with new challenges.
How should they evaluate these non-traditional indices? What
distinguishes a valid strategy index from one based on a random
back-test? Where does the dividing line between index-based and
discretionary fund management now lie? Does an asset-based or
factor-based approach to portfolio allocation make more sense?
Hotline: +44 (20) 7547 1747

etf@db.com
www.etf.deutscheawm.com
In this paper, authored by the passive asset management team at

Deutsche Asset and Wealth Management (Deutsche AWM 1), we
aim to answer these questions by putting the evolving role of
financial indices into a historical context, by providing a framework
to evaluate strategy indices and by suggesting how active and
passive approaches to investment can continue to coexist.
The principal and long-standing view of a financial index is as a
benchmark for the broad equity (or bond) market. In other words,
the index is seen as a way of measuring the systematic risk and the
associated return from the market as a whole.
In traditional asset management theory, the sensitivity of a portfolio
to market risk can be calculated and expressed as a coefficient,
called beta. A broad market index has a beta of one. A portfolio of
stocks with above-average sensitivity to market movements has a
beta of more than one, and a defensive portfolio has a beta of
below one. Positive alpha, the target of all active managers, means
an above-zero residual return once beta has been accounted for.
These conceptual shortcuts - beta for the passive, index-based part
of an investment portfolio and alpha for the actively managed
element that aims to add value, whether in absolute or relative
terms - remain largely in place amongst practitioners.
Content
1. Introduction
2. Combining Active and Passive
Investment Strategies
3. Factors Explored
4. Beyond Traditional Beta
1
4
9
19
But this theoretical framework is inadequate in a world where nontraditional indices offer exposure to different segments of the
market, blurring the lines between long-held concepts of passive
and active management.
On p.18 we outline Deutsche AWMs experience in managing passive investment mandates and the role of Deutsche Banks quantitative equity research team.
For Institutional Investors Only
Beyond Traditional Beta | March 2015

Investment strategies based on a systematic screening of the
market portfolio are not new. The principles of value-focused
investing, for example, were set out by Graham and Dodd before
the Second World War (Graham, Dodd, 1934) and have since been
successfully adopted by many investors.
But during the last two decades empirical evidence has
accumulated of the existence of multiple factors that provide a
more granular view of the behaviour of markets.
Within an equity portfolio, for example, the evidence suggests that
long-term performance can be explained not just by traditional beta
(market risk) and alpha (the value added by active management)
but also by exposure to factors such as value, size, momentum,
volatility and quality. And factor-based research has now extended
to the fixed income, commodity and currency markets.
More recently, new equity factor indices have also enabled
investors to capture exposure to factors in a systematic and
transparent way.
So the traditional concept of a single market beta has been
replaced by the idea of coexisting, multiple market betas. From a
portfolio perspective these betas can compete or work in a
complementary fashion. Prompted by the adoption of factor
strategies by some of the largest institutional investors in the world,
factor-based asset allocation is a research area attracting great
interest.
In the remainder of this paper, following a brief summary of the
historical evolution of financial indices, we examine equity factor
index approaches in detail. We describe how asset allocation
practice is changing to reflect the evolution of investment theory and
review how passive and active approaches to asset management
are likely to coexist in future. We set out a framework for evaluating
the key requirements for a valid strategy index before examining in
detail the risk/reward characteristics of common equity factor
approaches.
As markets move beyond the traditional concept of a single market
beta, our objective is twofold: to provide investors with a conceptual
framework to assess and evaluate newer forms of index in a
consistent fashion; and to help investors combine factor approaches
in their portfolios.

The Evolution of Indexing:
Theory and Practice?
The Evolution of Indexing
The use of indices in asset management

has evolved over time, mirroring
developments in academic theory (see
Figure 1). Most of the index funds
launched in the 1970s and 1980s aimed
to replicate the broad market portfolio, an
approach consistent with Portfolio
Theory (Markowitz, 1952) and the
Capital Asset Pricing Model (CAPMSharpe, 1964), theoretical market
models set out in the preceding decades.
1950s
1960s
Since the 1990s, increasing interest in

factor-based approaches to investment
have prompted widespread interest in
non-traditional beta. Advances in
computing power and extensive data
histories have helped researchers to
develop quantitative market models,
while falls in trading costs have made
real-time transactions in index-based
portfolios (for example, via the ETF
market) more feasible for a broad range
of investors.
Capital Asset Pricing

Model (CAPM)
Portfolio beta (systematic
risk) distinguished from
alpha (residual)
1970s
1980s
Portfolio Theory
Risk/return
modelled at portfolio
level
First commercial
index funds
developed
(Samsonite, Vanguard
Index Trust)
Popularisation of
index funds
New indices segment
markets by size,
geography,
development status
1990s
2000s
2010s
Fama-French/Carhart
publish studies of size,
value/momentum equity
market factors
First ETFs launched
Research into factors,

behavioural finance
extended
Rapidly increasing
usage of ETFs, index
funds
Popularisation of factorbased investment

strategies
Indexing overlaps with
quantitative investment
management
Source: Deutsche Bank AG

2.
Combining Active and Passive Investment

Strategies
Strategic Asset Allocation - the Traditional Approach

The traditional approach to long-term (strategic) asset allocation is set out
in Figure 2. Investment committees charged with setting asset allocation
policy have typically followed a three-step process.
The first step in the traditional process is to set target portfolio weightings
(or weighting ranges) for individual asset classes, such as bonds, equities
and alternatives. The key inputs in determining these target weightings are
long-term estimates of individual asset classes returns and volatility,
together with estimates of intra-asset class correlations. Allocations to
individual equity and bond markets (or market regions) are typically also
made at this first stage.
The second step in the traditional process is to decide on the
passive/active split within each asset class. Part of the target allocation to
equity and bond markets is then run in a passive (i.e., index-tracking)
manner, typically using a broad market index as the benchmark.
Responsibility for the remainder of the portfolio is then assigned to active
managers.
The third step in the process is to select the fund managers.
A traditional asset allocation process usually starts with the most important
decision, i.e., the strategic asset class targets. Overall, the equity/bond
split can be seen as the key decision from a return perspective: given
equities greater historical volatility and long-term return premium over
bonds, portfolios with greater risk appetite and higher return expectations
target a higher equity weighting, while those with more conservative risk
appetite target higher bond weightings.
A 60/40 target equity/bond weighting split has been called the classic
asset allocation recipe (Mesomeris, Wang, Salvini, Assetand-Fenoel,
2012). According to Christopher Brightman of Research Affiliates, a 60/40
portfolio of US equities and US bonds generated a nominal return of 7.6%
per annum and a real (post-inflation) return of 5.4% per annum over a
period of more than a century (1871-2010: Brightman, 2012).
Many US pension funds currently have long-term return targets that are
consistent with a 60/40 target asset allocation and with the expected
continuation of its historical returns: according to Boston Colleges Centre
for Retirement Research, the mean long-term nominal return assumption
2
of US pension funds in 2012 was 7.75% (Munnell, Aubry, Hurwitz, 2013).
In Europe pension funds return targets are somewhat lower. According to a survey of 190 European
pension funds with combined assets of 1.9 trillion, published in November 2014 by Create Research, the
median long-term nominal return expectation (net of fees) is 5% a year (Rajan, 2014).

2
The traditional approach to asset allocation
Asset Selection
Passive/ Active
Split Within Asset
Class
bonds/ equities/
alternatives
Manager
Selection
broad market
exposure for
passive
component
active/ passive
managers
chosen within
asset classes
Unstable Risk Contributions and Correlations

The principal drawback of this long-standing approach to asset allocation
is that certain assumptions implicit in the model may not hold in practice. In
particular, an asset class-based approach makes sense if the individual
portfolio building blocks can be relied upon to provide adequate levels of
diversification. This requires that the volatilities of individual asset classes,
though different, remain largely stable over time; and that the correlations
between asset classes are also relatively stable.
As is evident from Figures 3 and 4, these assumptions cannot be relied
upon.
Risk Contribution to 60/40 Portfolio by Asset Class
(January 1992 December 2014)
7%
93%
S&P 500
US 10 Year Govt Bond
Source: Deutsche Bank AG, Bloomberg Financial LP, 31/12/1991-31/12/2014,

based on five-year rolling returns and first five-year period ending 31/12/1996.

4
5-Year Rolling View of Risk Contribution to 60/40 Portfolio by Asset Class

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1996
2000
2004
US 10 Year Govt Bond
2008
2012
S&P 500
Source: Deutsche Bank AG, Bloomberg Financial LP, 31/12/1991-31/12/2014, based on five-year rolling returns and first
five-year period ending 31/12/1996.
Figure 3 (see previous page) shows that equity risk dominates the overall
risk of a 60/40 portfolio consisting of US equities and 10-year US
government bonds (equity risk contributed 93% of the portfolio risk during
1992-2014). And, based on a five-year rolling view of risk contribution,
equities contributed 90% or more of risk at certain points during this
historical window.
Using one-year historical correlations and volatilities, Bruder and Roncalli
showed that the equity component of a fund with a target 50/50 asset
allocation split between global equities and global bonds contributed up to
100% of the portfolio risk on two occasions between 2000-2012, both
during periods of market stress (Bruder, Roncalli, 2012).
A policy of relying on alternative asset classes (such as hedge funds,
property and commodities) to provide extra portfolio diversification has
also been questioned since the financial crisis.
Figure 5 illustrates the three-year rolling average pairwise correlation
between asset classes in a portfolio consisting of equities, bonds and four
popular alternative assets (hedge funds, real estate investment trusts,
commodities and private equities since 1999). The 2008 liquidity crisis
caused an unwelcome surge in pairwise correlations just at a time when
investors were relying on the extra diversification potential of alternative
assets.
3-Year Rolling Average Pairwise Correlations between Equities,
Bonds and Four Alternative Asset Classes
100%
80%
60%
40%
20%
0%
Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14
Average Pairwise Correlation
Source: Source: Deutsche Bank AG, Bloomberg Financial LP, 01/01/1991-31/12/2014, based on three-year rolling returns
and first three-year period ending 01/01/1994.

Allocation by Factors - an Alternative Approach
The period since the financial crisis has witnessed increasing interest in
alternative approaches to asset allocation, based on the recognition that
asset class volatilities and correlations can become particularly unstable in
times of market stress. The behaviour of markets in 2008/09 may reflect
the fact that notionally uncorrelated asset classes in fact share exposure to
common underlying drivers of returns: it therefore makes sense to try to
identify these common drivers or factors.
In an influential review of the active management of the Norwegian
Government Pension Fund portfolio, published in 2009, Professors Ang,
Goetzman and Schaefer concluded that a significant component of [the
portfolios] performance is explained by exposure to systematic factors
(Ang, Goetzman, Schaefer, 2009). While conceding that the factors fared
poorly during the financial crisis, the authors argued that exposure to such
factors is actually appropriate for a longterm investor since the factors
earn risk premiums over the long run.
Most importantly, Ang, Goetzman and Schaefer recommended that the
factor exposures be made part of the funds benchmark: in other words,
that either passive (index-tracking) or active managers be given the explicit
responsibility of generating the factor returns.
Several recent academic papers have focused on a factor-based approach
to asset allocation. Bender et al. showed that, based on historical
evidence, a portfolio of factor risk premia produced annual returns similar
to those of an asset-based portfolio, but with lower levels of correlation
between factors (Bender, Briand, Nielsen, Stefek, 2010). More recently,
Asness, Moskowitz and Pedersen have published evidence of the
existence of factor-type returns across non-equity asset classes (Asness,
Moskowitz, Pedersen, 2012).
A comprehensive review of factor-based asset allocation across asset
classes is beyond the scope of this paper. Nevertheless, we suggest how
such a factor-based approach might work in Figure 6. In the next section,
we focus in particular on equity factors and how to combine them.
6
A Factor-Based Asset Allocation Model
Risk/ return
budgeting
long-term
return goals
and risk
Factor Selection
Screening and
selection of
factors across
asset classes
Factor
weightings set
Manager
selection
Manager
appointed for
index-tracking
and factor
mandates

Fund Governance under FactorBased Allocation
Moving from a traditional to a factorbased asset allocation may require a
rethink of fund governance
arrangements.
This is because under a factor-based
allocation scheme explicit responsibility
for fund performance moves up the
decision-making chain, away from active
portfolio managers (in the traditional
model) and towards those setting the
factor allocation.
It is therefore important that those
responsible for fund governance (e.g.,
pension fund trustees) set out a
transparent framework for reporting and
performance evaluation. Trustees should
be well acquainted with the risk-return
characteristics of different factors and
with the possibility that certain factors
may underperform broad market indices
for extended periods in particular market
environments. Factor risk characteristics
are explored in further detail in the next
section.
Active Management - a Continuing Role

Moving from an asset class-based to a factor-based asset allocation does
not necessarily imply a downsized role for active portfolio management.
Although part of the long-term portfolio returns traditionally assumed to
accrue from alpha may now be seen as the result of exposure to
systematic factor risk premia (see Figure 7), the decision on whether to
implement an actively or systematically rebalanced factor allocation is the
focus of an increasingly intense debate.
The optimal allocation to factors is indeed a complex topic. While several
managers aim to generate active returns by switching between factors
across time (i.e., implementing so-called factor timing strategies) most of
the investors looking at factor investing are currently contemplating a
passively rebalanced portfolio of factors. The main reason for this is
probably that the risks induced by factor timing (namely missing a rally of
an under-weighted strategy while in the meantime suffering from the
drawdown of an over-weighted strategy) are ultimately considered as
higher than the potential gains brought by such an approach.
A Changing View of the Sources of Portfolio Returns

3.
Factors Explored
As outlined in the previous section, a shift has taken place amongst both
academics and practitioners regarding the sources of equity portfolio
returns.
From viewing returns as a simple combination of beta (systematic, broadbased market risk) and alpha (the result of active manager skill), investors
now increasingly regard systematic beta - the return derived from
exposure to identifiable equity factors - as a third, distinct component of
performance.
Systematic beta is also often referred to as strategic or smart beta. We
prefer to avoid the latter term: traditional broad indices are likely to remain
the principal type of market benchmark, so should not be seen as any less
valid or useful than newer forms of index.
How a Factor Model Works: an Example

The way in which financial theory has evolved from the single-factor
Capital Asset Pricing Model (CAPM) of the 1960s can be understood by
means of an example: the three-factor model outlined by Eugene Fama
and Kenneth French in 1992 (Fama, French, 1992).
Fama and French found that, based on 50 years of equity market data,
there was only a weak relation between beta (as understood in the CAPM
framework) and average stock returns. Instead, they found that a multifactor model using market beta plus two additional factors (size and value)
had much better explanatory power.
The Fama-French three-factor model is commonly stated as
where:
= the portfolios expected rate of return
= the risk-free rate of return
= the return of the market portfolio
= the size factor (Small Minus Big)
= the value factor (High book value to market value ratio Minus
Low")
and
= coefficients for the market, size and value factors
= residual (alpha), the result of active management decisions.
Since Fama and French introduced their three-factor model in 1992,

researchers have produced evidence for the existence of additional
factors, all with the ability to contribute to our understanding of equity
market returns. These factors include quality (Sloan, 1996), momentum
(Jegadeesh and Titman, 1993) and low beta (Baker, Bradley and Wurgler,
2011).

Screening Factors
Below we explore in further detail the risk/return characteristics of these
factors. However, since all factors are identified by means of the study of
empirical data on securities returns, a question immediately arises: what
distinguishes a true factor from one that may be the coincidental result of
the data and period used for the analysis? In other words, how confident
can investors be that the factor characteristics identified in sample will
persist out of sample?
Deutsche AWM aims to address such concerns by requiring the factors
chosen in its equity factor product range to undergo a screening process,
outlined in Figure 8.
8
The Factor Screening Process
Explainable
Accessible
Established
Equity
Factors
Persistent
Attactive
To pass the screening process, equity factors should be:
explainable (they should have a strong basis for existence and be

uniquely identifiable)
established (they should have a well-established history in academic
literature)
attractive (they should offer potential for attractive long-term
risk/return)
persistent (there should be a rationale for the persistence of the
factor risk premium)
accessible (they should be accessible at a level of cost that avoids
the dilution of the factor premium)
10

Factor Characteristics: Value
The risk premium associated with the value factor is well-established in
academic and practitioner literature. Indeed, value-focused investment
strategies predate academic theories such as CAPM and the subsequent
multi-factor models of market behaviour.
For example, in the 1930s Graham and Dodd described their preferred
approach as the discovery of undervalued individual common stocks,
which presumably are available even when the general market is not
particularly low, and whose margin of safety resides in the discount at
which the stock is selling below its minimum intrinsic value.
Six decades later Fama and French described value (and size) as two of
the three factors (together with market risk) with significant ability to
explain stocks long-term returns.
Value can be measured in different ways, for example via stocks price-tobook value ratios (the method used by Fama and French in their 1992
paper), their price-to-earnings ratios, their dividend yield or by a ratio of
standardised earnings to enterprise value.
The DB Equity Value Factor Index relies on two equally weighted
measures of value to determine a companys composite value factor
score: 12-month trailing dividend yield and the ratio of earnings before
interest, tax, depreciation and amortisation (EBITDA) to enterprise value
(EV). These two components can be seen as complementary: yield is a
more defensive measure, while the EBITDA/EV ratio (earnings power) is a
more cyclical measure of value.
In the DB Equity Value Factor Index, companies yield and earnings power
are compared to their sector averages and weightings are then neutralised
across sectors. This is done with the aim of ensuring that structural
differences in value scores between different types of company do not
result in imbalanced sector weightings at the index level.
9
The Factor Screening Process
Explanations for the existence of factor risk premia commonly fall into two
categories: risk-based and behavioural. The risk-based (or economic)
explanation is more consistent with concepts of market efficiency, since
the return associated with a factor risk premium is seen as compensation
to an investor for bearing a type of systematic risk. Behavioural
explanations for factor risk premia tend to focus more on investor
irrationality or on market inefficiencies.
Risk-based explanations for the value factor premium include: the higher
potential exposure of value stocks (given their low valuation) to financial
distress or default; higher cash flow risk; and value stocks greater
sensitivity (by comparison with growth stocks) to economic downturns.
11

Behavioural explanations for the value premium focus more on investors
perceived irrationality in mispricing growth stocks. According to this theory,
in aggregate investors tend to extrapolate fast-growing companies growth
rates too far into the future, overpaying for growth stocks as a result. Value
companies, to which no such growth premium is attached, then tend to
outperform the broader market over the long term.
The attractiveness of a value factor investment strategy has been
demonstrated by the widely documented long-term outperformance of
broad market indices by value strategies (see, for example, Asness,
Moskowitz, Pedersen, 2012).
The likely persistence of a value strategys returns should be evaluated in
the context of the explanation for the sources of the value factor premium:
if the source of the premium is risk-based, it is unlikely that it will
disappear; if the source of the premium reflects market inefficiencies, such
as the tendency of institutional investors to benchmark their performance
against broad market indices (which, by their nature, may be seen as
having a natural tilt towards growth stocks), or the inability of many
investors to sell short overpriced stocks, then these inefficiencies also
seem likely to persist.
Value can be seen as one of the most accessible factor investment
strategies: despite the long-standing popularity of the strategy, there is
little evidence that there has been dilution of the factor risk premium, nor of
any significant investment capacity constraints in portfolios replicating
value factor indices. By comparison with some other non-traditional
indices, a value factor index does not rely, for example, on substantial
weightings in smaller-capitalisation stocks.
12

Factor Characteristics: Quality
In an influential 1996 paper, Richard Sloan of the University of
Pennsylvania argued that investors appear unable to distinguish between
the cash flow and accruals components of corporate earnings, even
though empirical evidence shows that the relative magnitude of the cash
and accruals components has an impact on the durability of current
earnings. Fundamentally, accruals can be seen as less reliable earnings
than cash flow, since they involve subjective judgments regarding the
period in which revenues and expenses are recognised.
Sloans paper followed another influential study of the potential for
discrepancies between reported earnings and earnings based on cash
flow, authored by stock analyst Terry Smith (Smith, 1992), then head of
UK company research at UBS Phillips and Drew. Smith said he wished to
investigate why several large and ostensibly profitable UK quoted
companies, such as Polly Peck and British & Commonwealth, had gone
bankrupt in the early 1990s, and concluded that investors needed to pay
more attention to companies cash flow.
The DB Equity Quality Factor index uses two accounting metrics to
determine a companys quality score: return on invested capital (ROIC), a
measure of profitability, is combined with the year-on-year change in
accruals based on net operating earnings. The higher the ROIC score and
the lower the accruals score, the higher the quality score.
In the DB Equity Quality Factor index, ROIC and change in accruals are
compared to their sector averages and weightings are then neutralised
across sectors. Financial stocks are excluded from the index as a result of
their special accounting characteristics.
Determining the Quality Factor Score
10
The quality anomaly is well-established in academic and practitioner

literature. Smiths and Sloans studies from the 1990s have been followed
by a number of other papers examining the accruals effect (Chan, Chan,
Jegadeesh and Lakonishok, 2001; Fairfield, Whisenant, Yohn, 2003).
Explanations for the existence of the quality factor premium focus on
behavioural inefficiencies. Simply stated, the quality premium may reflect
investors lack of attention to the different components of reported
earnings. This inattention then causes stocks with relatively high or low
accruals components to be mispriced, an effect that can be exploited
systematically.
Several studies have shown that stocks selected according by the
underlying components of the quality factor scoring process exhibit high
attractiveness from a risk/return perspective. For example, a 2011 paper
showed that high accruals are negatively related to future earnings
changes and stock returns (Allen, Larson, Sloan, 2011).
13

The likely persistence of the accruals anomaly has been widely studied.
While some academics suggest that its effect has weakened over time (for
example, Green, Hand, Soliman, 2009), others argue that it will persist as
a reflection of behavioural inefficiencies among investors (Hirshleifer, Hou,
Teoh, 2012). Additionally, Deutsche Banks policy of combining accruals
and ROIC to measure a companys quality score means that low accruals
must be complemented by a real economic return.
The accruals anomaly has been documented across markets, industries
and in larger and smaller companies, suggesting that accessibility to a
quality strategy is relatively unrestricted.
14

Factor Characteristics: Momentum
The momentum factor aims to exploit the tendency for trends in stock price
movements to persist over time.
Jegadeesh and Titman showed in a paper published in 1993 that a
strategy which simultaneously buys past winners and sells past losers
generates significant abnormal returns over holding periods of between
three months and a year (Jegadeesh, Titman, 1993). These abnormal
profits appear to be independent of market, size or value factors and can
be observed in market data from different countries and regions, and
across asset classes.
The DB Equity Momentum Factor Index uses a two-step process to
determine a companys momentum score (see Figure 11): first, the 11month momentum of a stock is calculated by dividing its price one month
earlier by the price 12 months earlier; second, the momentum is
neutralised by adjusting for each companys specific risk.
11
Determining the Momentum Factor Score
The abnormal returns generated by a strategy that is long past winners

and short past losers have been well-documented, ensuring that the
momentum factor is one of the best-established risk premia in academic
literature.
Most explanations for the existence of the momentum factor focus on
behavioural anomalies and structural market inefficiencies. Behavioural
economists posit that investors initially underreact, then overreact to
information affecting share prices. Institutional explanations for the
momentum premium suggest that, by focusing on broad market indices for
performance measurement purposes and by seeking to minimise the risk
of underperforming such benchmarks, many investors reinforce stock price
trends.
The attractiveness and persistence of a momentum strategy have been
established in multiple academic studies, across markets and over
extended time periods. However, momentum tends to suffer sharp
reversals during periods of changing market risk appetite. In other words, a
pure momentum strategy generates high Sharpe ratios and positive
alphas, but also negatively skewed return streams (see Daniel, Moskowitz,
2013).
One way of mitigating this potential negative skewness in the returns of a
momentum strategy is to aim to separate the momentum factor from a
stocks embedded volatility exposure (see Alvarez, Kassam and
Mesomeris, 2010): this is the methodology employed by the Deutsche
Bank Equity Quantitative Strategy Group to determine a stocks
momentum score.
Momentum is one of the more accessible and high-capacity factor
investment strategies: for example, its returns do not depend on the
overweighting of less liquid segments of the market, such as smallcapitalisation stocks.
15

Factor Characteristics: Low Beta
The low beta (also known as the low volatility) anomaly may be regarded
as one of the most puzzling findings in finance. In a recent, 40-year study
of stock returns, low-beta portfolios were demonstrated to offer both higher
returns and lower drawdowns than the broad market index (see Baker,
Bradley, Wurgler, 2011).This establishes the attractiveness of an
investment strategy focused on low-beta stocks.
This outcome runs counter to the fundamental principles of portfolio theory
and CAPM, under which a higher-beta portfolio should offer higher
expected returns. In another, similar study a strategy of betting against
beta was shown to have a Sharpe Ratio twice as high as a value strategy
and 40% higher than a momentum strategy (see Frazzini, Pedersen,
2011).
The low beta anomaly is not a recent discovery: it was pointed out over
four decades ago (see Black, Jensen, Scholes, 1972) and confirmed by
Haugen and Baker in 1991 (Haugen, Baker, 1991). In other words, this
factor risk premium is one of the most well-established in academic
literature.
The DB Equity Low Beta Index uses a straightforward process to
determine a companys low beta score (see Figure 12): the covariance of a
stocks returns to the returns of the overall market is divided by the market
variance, with all measurements taken over a five-year period.
12
Determining the Low Beta Factor Score
The most popular explanations for the existence of the low-beta anomaly
are behavioural. According to such theories, many investors overpay for
perceived lottery stocks - i.e., those that promise high rates of return leaving less glamorous low-beta stocks relatively underpriced and with the
ability to outperform. In chasing such stock market winners, investors may
be suffering from the behavioural trait of overconfidence (most
respondents to surveys seem to think they are better-than-average drivers,
or that they can outperform the stock market).
The persistence of the returns from low-beta investing has been welldocumented: Frazzini and Pedersen (2011) found that low-beta stocks had
outperformed in 18 of 19 global equity markets they studied. The authors
also documented a low-beta effect in government, corporate bond and
futures markets.
As the low-beta effect has been documented across markets and in
different capitalisation segments, the accessibility of this factor for a
systematic investment strategy can be ranked as relatively high.
16

Combining Factors in a Portfolio
Traditionally considered as difficult to forecast, the relative performance of
the four factors described above depends on the macroeconomic
environment.
For example, during inflationary growth periods quality does relatively well,
while momentum and value tend to outperform low beta. In a stagflationary
period low beta does well, while momentum and quality outperform value.
The value factor performs best in reflationary and disinflationary periods
(see Figure 13, where the performance of the capitalisation-weighted
MSCI World index is also shown for reference).
Simulated Factor Performance in Different Macro Environments
13
Source: Deutsche Bank AG. The returns shown for the value, quality, momentum and low beta factors are based on the
returns of the Deutsche Bank Equity Factor Indices of the same name over the period 31.12.2000-31.12.2014. The Deutsche
Bank Equity Factor Indices have no prior operating history and the returns illustrated are based on the retroactive application
of the index methodology. Performance is calculated in total return USD and shown gross of dividend withholding tax,
rebalancing and index costs. Past performance, actual or simulated, is not a reliable indicator of future returns.
Detailed performance metrics for the factor indices included in Figure 13

are shown in Appendix 1.
The tendency of the four equity factors to perform differently in different
macroeconomic environments suggests that investors may gain significant
diversification benefits by combining the factors in a portfolio.
While there are many approaches to combining equity factors, investors
often consider the following weighting methods:
Equal Weighting;
Risk Parity Weighting (given the similar historical volatilities of the
four factors, this allocation is broadly similar to equal-weighting);
Momentum-based allocation (e.g., selecting the two of the four
factors with the highest 11-month momentum and allocating 70%
and 30%, respectively, to the factors with the highest and secondhighest momentum, respectively).
A simulated performance record of the equal-weighted and momentumbased factor portfolios over the period 2000-2014 is shown in Figure 14
(see next page), with the MSCI World index included for comparison.
17

Choosing a Fund Structure
Simulated Performance of Factor-Based Equity Portfolios
14
The passive asset management team at

Deutsche AWM offers a full range of
capabilities, from the development of
investment strategies, fund and ETF
structuring to the physical replication of
large, index-based portfolios. These
portfolios track a variety of indices, from
popular benchmarks to sophisticated
strategy indices.
The firm is already a prominent global issuer
of ETFs (according to Lan et al., 2015,
Deutsche AWM was the second largest ETF
issuer in Europe and the fifth largest globally
as at end 2014), as well as passive funds
and segregated mandates. Now, Deutsche
AWM has designated passive asset
management as a key growth area and
made significant investments in people,
platforms and product development to
achieve this goal.
Through its strategic beta product range,
Deutsche AWMs passive asset
management team provides, cost-efficient,
alternatively weighted strategies which aim
to achieve optimized risk-adjusted returns
when compared with their benchmarks. To
deliver this objective, whether in flagship
products like ETFs or in customised
segregated mandates, Deutsche AWM
Passive Asset Management may rely on
internal and external research, index
providers and its own portfolio construction
expertise.
Source: Deutsche Bank, Bloomberg, 31.10.2001 31.12.2014. The performance data in this section is based on monthly
data calculated in USD and shown gross of rebalancings and index costs. All rebalancing in the hypothetical portfolios are
done at zero costs. The Equity Factor Indices have no prior operating history. All performance data is simulated and
calculated by means of a retrospective application of the index methodology.The simulated returns of the hypothetical
returns are based on the backtested performance of the Equity Factor Indices before the launch date (Sept. 14). Past
performance, actual or simulated, is not a reliable indicator of future results.
Over the years Deutsche Bank has

developed significant expertise in equity
factors, as evidenced by the numerous
publications from the banks Equity
Quantitative Strategy Group. This groups
research in factor identification and portfolio
construction is considered to be marketleading by surveys of large institutional
clients.3
This research expertise, combined with
extensive experience in portfolio
construction, optimised replication and
efficient execution, puts Deutsche AWMs
Passive Asset Management team in a
strong position to implement a large range of
equity factor portfolios.
The DB Quantitative Strategy Group was ranked #1 in both the 2011 & 2012 All-Europe Institutional
Investor Research Survey and the 2011 & 2012 US Research Institutional Investor Survey. Both the
US and Europe teams were ranked in the top 3 in the Greenwich Survey for 2011.
18

4.
In this paper we have described how a broad range of transparent,

systematic and standardised equity investment strategies, based upon
developments in academic theory, is becoming available to investors.
A rapidly increasing interest in strategies focused on factor risk premia is
evident across a broad range of investor categories, including some of the
worlds largest institutional investors. This trend poses challenges for
traditional models of portfolio asset allocation and fund governance. We
have outlined how alternative approaches in both these areas might be
structured.
We presented the screening process used by the DB Equity Factor Indices
to identify factors with long-term viability and investment capacity, before
reviewing in detail the risk/return characteristics of four popular equity
factor strategies: value, quality, momentum and low beta.
Finally, we discussed the relative performance of factor strategies in
different market environments and examined potential ways of combining
equity factors in a portfolio.
Broad market indices remain central in investment management practice,
both as the basis for the measurement of active managers performance
and as the target for many index-tracking portfolios.
However, the evolution of investment theory towards a world involving
multiple, systematic sources of risk and return is now well-entrenched. As
a result, non-traditional beta is only likely to grow in importance over the
coming decades.
Simulated Performance of DB Equity Factor Indices (2000-2014)
Appendix 1
Source: Deutsche Bank AG, Bloomberg LP, 31.10.2001 31.12.2014. The DB Equity Factor Indices have no prior operating
history before September 2014. All performance data is simulated and calculated by means of a retrospective application of
the index methodology before the launch date . Performance is calculated in total return USD and shown gross of dividend
withholding tax, rebalancing and index costs. Past performance, actual or simulated, is not a reliable indicator of future
results.
vs MSCI World over previous one year period.
2
vs MSCI World over the observation window starting on 31.10.2000 and ending on 31.12.2014.
19

References
Allen, E., Larson, C., Sloan, R., Accrual Reversals, Earnings and Stock
Returns, 2011
Alvarez, M-A., Kassam, A., Mesomeris, S., Factor Neutralization and Beyond,
2010
Ang, A., Goetzmann, W., Schaefer, S., Evaluation of Active Management of
the Norwegian Government Pension Fund Global, 2009
Asness, C., Moskowitz, T., Pedersen, L., Value and Momentum Everywhere,
2012
Baker, M., Bradley, B., Wurgler, J., Benchmarks as Limits to Arbitrage:
Understanding the Low-Volatility Anomaly, 2011
Bender, J., Briand, R., Nielsen, F., Stefek, F., A New Approach to
Diversification, 2010
Black, F., Jensen, M., Scholes, M., The Capital Asset Pricing Model: Some
Empirical Tests, 1972
Brightman, C., Expected Return, 2012
Bruder, B., Roncalli, T., Managing Risk Exposures Using the Risk Budgeting
Approach, 2012
Chan, K., Chan, L., Jegadeesh, N., Lakonishok, J., Earnings Quality and Stock
Returns, 2001
Daniel, K., Moskowitz, T., Momentum Crashes, 2013
Fairfield, P., Whisenant, S., Yohn, T., Accrued Earnings and Growth:
Implications for Future Profitability and Market Mispricing, 2003
Fama, E., French, K., The Cross-Section of Expected Stock Returns, 1992
Frazzini, A., Pedersen, L., Betting against Beta, 2011
Graham, B. and Dodd, D., Security Analysis, 1934
Green, J., Hand, J., Soliman, M., Going, Going, Gone? The Demise of the
Accruals Anomaly, 2009
Haugen, R., Baker, N., The Efficient Market Inefficiency of CapitalizationWeighted Stock Portfolios, 1991
Hirshleifer, D., Hou, K., Teoh, S., The Accrual Anomaly: Risk or Mispricing?,
2012
Jegadeesh, N., Titman, S., Returns to Buying Winners and Selling Losers:
Implications for Stock Market Efficiency, 1993
Lan, Mercado, Rajendra, Gademsetty, Deutsche Bank ETF Annual Review &
Outlook, 2015
Markowitz, H., Portfolio Selection, 1952
Mesomeris, S., Wang, Y., Salvini, M., Avettand-Fenoel, J-R., A New Asset
Allocation Paradigm, 2012
Munnell, A., Aubry, J-P., Hurwitz, J., How Sensitive is Public Pension Funding
to Investment Returns?, 2013
Rajan, A., The Alpha behind Alpha: Rebooting the Pension Business Models,
2014.
Sharpe, W., Capital Asset Prices: A Theory of Market Equilibrium under
Conditions of Risk, 1964
Sloan, R., Do Stock Prices Fully Reflect Information in Accruals and Cash
Flows about Future Earnings?, 1996
20

Risk Factors db X-trackers UCITS ETFs
Investors should note that the db X-trackers UCITS ETFs are not capital protected or
guaranteed and investors in each db X-trackers UCITS ETF should be prepared and
able to sustain losses of the capital invested up to a total loss.
The value of an investment in a db X-trackers UCITS ETF may go down as well as up
and past performance is not a guide to the future.
Investment in db X-trackers UCITS ETFs involve numerous risks including among
others, general market risks relating to the relevant index, credit risks on the provider
of index swaps utilised in the db X-trackers UCITS ETFs, exchange rate risks,
interest rate risks, inflationary risks, liquidity risks and legal and regulatory risks.
Not all db X-trackers UCITS ETFs may be suitable for all investors so please consult
your financial advisor before you invest in a db X-trackers UCITS ETF
db X-trackers UCITS ETFs following a direct replication investment policy, may
engage in securities lending. In these instances the db X-trackers UCITS ETFs face
the risk of the borrower not returning the securities lent by the db X-trackers UCITS
ETF due to e.g. a default situation and the risk that collateral received by the db Xtrackers UCITS ETFs may be liquidated at a value lower than the value of the
securities lent out by the db X-trackers UCITS ETFs.
db X-trackers UCITS ETFs employing an indirect investment policy will use OTC
derivative transactions. There are appropriate arrangements in place to reduce the
exposure of the db X-trackers UCITS ETF to the counterparty, in some cases up to
100%, but there is no guarantee that such arrangements will be perfect and the
counterparty may lose up to 100% of its investment if the counterparty defaults.
db X-trackers UCITS ETFs may be unable to replicate precisely the performance of
an index.
An investment in a db X-trackers UCITS ETFs is dependent on the performance of
the underlying index less costs, but an investment is not expected to match that
performance precisely. There may be a tracking difference between the performance
of the db X-trackers UCITS ETFs and the underlying index e.g. due to the impact of
fund management fees and administrative costs among other things. The returns on
the db X-trackers UCITS ETFs may not be directly comparable to the returns
achieved by direct investment in the underlying assets of the db X-trackers UCITS
ETFs or the underlying index. Investors' income is not fixed and may fluctuate.
db X-trackers UCITS ETFs shares may be denominated in a currency different to that
of the traded currency on the stock exchange in which case exchange rate
fluctuations may have a negative effect on the returns of the fund.
The value of any investment involving exposure to foreign currencies can be affected
by exchange rate movements.
Tax treatment of the db X-trackers UCITS ETFs depends on the individual
circumstances of each investor. The levels and bases of, and any applicable relief
from, taxation can change.
DB Affiliates significant holdings: Investors should be aware that Deutsche Bank or its
affiliates (DB Affiliates) may from time to time own interests in any individual db Xtrackers UCITS ETF which may represent a significant amount or proportion of the
overall investor holdings in the relevant db X-trackers UCITS ETF. Investors should
consider what possible impact such holdings by DB Affiliates may have on them. For
example, DB Affiliates may like any other Shareholder ask for the redemption of all or
part of their Shares of any Class of the relevant db X-trackers UCITS ETF in
accordance with the provisions of this Prospectus which could result in (a) a reduction
in the Net Asset Value of the relevant db X-trackers UCITS ETF to below the
Minimum Net Asset Value which might result in the Board of Directors deciding to
close the db X-trackers UCITS ETF and compulsorily redeem all the Shares relating
to the db X-trackers UCITS ETF or (b) an increase in the holding proportion of the
other Shareholders in the db X-trackers UCITS ETF beyond those allowed by laws or
internal guidelines applicable to such Shareholder.
db X-trackers shares purchased on the secondary market cannot usually be sold
directly back to the db X-trackers ETFs. Investors must buy and sell shares on a
secondary market with the assistance of an intermediary (e.g. a stockbroker) and
may incur fees for doing so. In addition, investors may pay more than the current net
asset value when buying shares and may receive less than the current net asset
value when selling them.
Full disclosure on the composition of the db X-trackers UCITS ETFs portfolio and
information on the Index constituents, as well as the indicative Net Asset Value, is
available free of charge at www.etf.deutscheawm.com . For further information
regarding risk factors, please refer to the risk factors section of the prospectus, or the
Key Investor Information Document.
21

Disclaimer
This marketing communication is intended for professional clients / qualified investors only.
The information contained in this document does not constitute investment advice. Complete
information on the sub-funds including risks can be found in the prospectus of Concept Fund
Solutions plc ("CFS") as well as the relevant supplements in their prevailing version. These and
the relevant key investor information documents constitute the only binding sales documents for
the sub-funds.
Germany:
Investors can obtain these documents along with copies of the articles of association and the
latest published annual and semi-annual reports from the Paying and Information Agent,
(Deutsche Bank AG, Institutional Cash & Securities Services, Issuer Services, Post IPO
Services, Taunusanlage 12, 60325 Frankfurt am Main (Germany)) in German in printed form
free of charge, or download them from www.etf.db.com.
Austria:
Investors can obtain these documents for sub-funds that are admitted for distribution in Austria,
along with copies of the articles of association and the latest published annual and semi-annual
reports from the Austrian Paying Agent, Deutsche Bank sterreich AG, Stock im Eisen-Platz 3,
A-1010 Vienna, in German in printed form free of charge, or download them from
www.etf.db.com.
Switzerland:
Investors can obtain these documents along with copies of the articles of association and the
latest published annual and semi-annual reports from the Swiss Representative in German in
printed form free of charge, or download them from www.etf.db.com. The Representative and
Paying Agent in Switzerland for the sub-funds is Deutsche Bank (Suisse) S.A., Place des
Bergues 3, 1201 Geneva and its branch offices in Zurich and Lugano. All statements of opinion
reflect the current assessment of Deutsche Bank AG and are subject to change without notice.
All statements of opinion reflect the current assessment of Deutsche Bank AG and are subject
to change without notice.
As explained in the prospectus of CFS plc, distribution of the aforementioned sub-funds is
subject to restrictions in certain jurisdictions. For this reason, the sub-funds mentioned herein
may neither be offered nor sold in the USA, nor to, or for the account of, US persons or persons
residing in the USA.
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jurisdictions in which such distribution and publication is permissible in accordance with
applicable law in those jurisdictions. Direct or indirect distribution of this document is prohibited
in the USA as well as to or for the account of US persons and persons residing in the USA. All
prices shown here are provided for informational purposes only and do not serve as an indicator
of trading prices.
The calculation of performance uses the BVI (Bundesverband Investment und Asset
Management) method and therefore does not take the Upfront Sales Charge into account.
Individual costs such as fees and other charges, which would have a negative impact on the
performance, have not been taken into account.
The information contained in this document does not constitute a financial analysis but qualifies
as marketing communication. This marketing communication is neither subject to all legal
provisions ensuring the impartiality of financial analysis nor to any prohibition on trading prior to
the publication of financial analyses.
22

This document is intended for discussion purposes only and does not create any legally
binding obligations on the part of Deutsche Bank AG and/or its affiliates (DB).This material
was not produced, reviewed or edited by the Research Department, except where specific
documents produced by the Research Department have been referenced and reproduced
above. Without limitation, this document does not constitute an offer, an invitation to offer or a
recommendation to enter into any transaction. When making an investment decision, you
should rely solely on the final documentation (including the most recent key investor
information document, which is available in English and certain other relevant languages on
www.etf.db.com) relating to the transaction and not the summary contained herein. These
documents are available free of charge from Deutsche Bank, London Branch. DB is not
acting as your financial adviser or in any other fiduciary capacity with respect to this proposed
transaction. The transaction(s) or products(s) mentioned herein may not be appropriate for all
investors and before entering into any transaction you should take steps to ensure that you
fully understand the transaction and have made an independent assessment of the
appropriateness of the transaction in the light of your own objectives and circumstances,
including the possible risks and benefits of entering into such transaction. For general
information regarding the nature and risks of the proposed transaction and types of financial
instruments please go to www.globalmarkets.db.com/riskdisclosures.You should also
consider seeking advice from your own advisers in making this assessment. If you decide to
enter into a transaction with DB, you do so in reliance on your own judgment. The information
contained in this document is based on material we believe to be reliable; however, we do not
represent that it is accurate, current, complete, or error free. Assumptions, estimates and
opinions contained in this document constitute our judgment as of the date of the document
and are subject to change without notice. Any projections are based on a number of
assumptions as to market conditions and there can be no guarantee that any projected
results will be achieved. Past performance is not a guarantee of future results. The DB Factor
Indices have no prior operating history. All performance data is simulated and calculated by
means of a retrospective application of the index methodology. Performance is calculated in
total return USD and shown gross of dividend withholding tax, rebalancing and index costs.
Past performance, actual or simulated, is not a reliable indicator of future results. Any
opinions expressed herein may differ from the opinions expressed by other DB departments
including the Research Department. DB may engage in transactions in a manner inconsistent
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interests in any individual sub-fund of CFS which may represent a significant investment or
proportion of the overall investor holdings in the relevant sub-fund. Investors should consider
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with making such an investment and has sufficient financial resources to sustain any loss that
may arise from it.
CFS is an investment company with variable capital incorporated on 17 November 2004 and
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pursuant to the European Communities (Undertakings for Collective Investment in
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(competent authority: BaFin Federal Financial Supervising Authority) and DB AG London
Branch is regulated by the Financial Conduct Authority for the conduct of UK business.
Deutsche Bank AG 2015. All rights reserved.
db X-trackers_1700
23
Deutsche Asset & Wealth Management represents the asset management and wealth management activities
conducted by Deutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset & Wealth
Management products or services by one or more legal entities that will be identified to clients pursuant to the
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2015 Deutsche Asset & Wealth Management. All rights reserved.

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March 2015

Beyond Traditional Beta

Hotline: +44 (20) 7547 1747

In this paper, authored by the passive asset management team at

For Institutional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

The Evolution of Indexing

The use of indices in asset management

Since the 1990s, increasing interest in

Capital Asset Pricing

Research into factors,

Popularisation of factorbased investment

Source: Deutsche Bank AG

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

Combining Active and Passive Investment

Strategic Asset Allocation - the Traditional Approach

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

The traditional approach to asset allocation

Source: Deutsche Bank AG

Unstable Risk Contributions and Correlations

US 10 Year Govt Bond

Source: Deutsche Bank AG, Bloomberg Financial LP, 31/12/1991-31/12/2014,

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

5-Year Rolling View of Risk Contribution to 60/40 Portfolio by Asset Class

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

A Factor-Based Asset Allocation Model

Source: Deutsche Bank AG

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

Active Management - a Continuing Role

Source: Deutsche Bank AG

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

How a Factor Model Works: an Example

Since Fama and French introduced their three-factor model in 1992,

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

The Factor Screening Process

Source: Deutsche Bank AG

To pass the screening process, equity factors should be:

For Professional Investors Only

explainable (they should have a strong basis for existence and be

Beyond Traditional Beta | March 2015

Beyond Traditional Beta

The Factor Screening Process

Source: Deutsche Bank AG

For Professional Investors Only

Beyond Traditional Beta | March 2015

Beyond Traditional Beta