Dec 2017-Jan 2018

TRADE TALK: Is smart beta the new passive?

Our panel of experts offer their thoughts on the fast-growing field of smart beta investing and whether it is becoming more of a threat than index tracking to the traditional active management of funds.


ADAM LAIRD, HEAD OF ETF STRATEGY FOR NORTHERN EUROPE, LYXOR ETF

Will smart beta form part of all investment portfolios within a decade, as mike O’Brien of JP Morgan Asset Management suggested recently?
When investors look at their portfolios, they think in terms of objectives: this is for income, this is for high returns, this is to control risk. And in the past, passive strategies were for broad market exposure – when you needed a little spice or protection, you used an objectives-based active manager.

Smart beta has changed this. Smart beta indices can now select high dividends, choose stocks on fundamentals or control volatility – moreover, they do this at a fraction of the cost of a stock-picker.

Yes, I believe most portfolios will use smart beta in the next ten years. If you’re a fund selector, your default position should be a tracker fund or exchange-traded fund unless an active manager can prove she’s worth the extra cost. Objective investing is no different.

The early adopters of smart beta have been the institutions – pension and sovereign wealth funds who were quick to hire experts.

But these strategies have now become commonplace and investors are more and more comfortable. There is €33.3 billion invested in Europe currently – that will only grow further.


BRUNO TAILLARDAT, GLOBAL HEAD OF SMART BETA & FACTOR INVESTING, AMUNDI

What was the worst-performing smart beta factor over the past 12 months and why?
As they are not impacted by the same variables, factors perform differently depending on market conditions, meaning that some periods are more favorable to a factor than others. The last 12 months showed strong risk appetite from investors.

Such a market environment is not very favourable to defensive factors, such as low volatility or high dividend yield, making them the worst-performing factors over the last 12 months.

However, a factor such as low vol shows today lots of interest in a portfolio allocation as it can bring risk diversification. When combined with other factors, it can contribute to deliver long-term performance even in a market context driven by risky assets.

At Amundi, we offer several approaches to meet investors’ needs and requirements: either through a passive and systematic mono/multi-factor index, or a risk-budgeting allocation over several factors to adapt to the risk environment.


BOYAN  FILEV, CO-HEAD QUANTITATIVE EQUITIES AND THE MEDIA TEAM, ABERDEEN STANDARD INVESTMENTS

Is smart-beta an opportunity or a threat to active managers?
Aberdeen Standard Investments believe that smart beta is a third approach to equity investing that sits alongside traditional active and market capitalisation passive management.

Smart beta, however, could be perceived as a threat to some active managers who struggle to justify the drivers of their excess returns and are viewed as ‘closet factor investors’.

Smart beta, particularly multi-factor investing, can deliver above-market returns similar to active management whilst retaining the transparency, objectivity and the relatively lower costs associated with passive management.

The changing landscape following the global financial crisis is one of regulation driving costs down, increased investor sophistication and technological innovations in data-gathering,  meaning asset managers must adapt and deliver a broader range of products to meet the growing need for solution- based products.

This change in investor demands and expectations suits smart beta products with its strength and flexibility in enabling solutions-based investing. This is evidenced  by the quick uptake in socially responsible  smart beta investing as investor focus shifts towards societal benefits in addition to meeting long- term fiduciary goals.


BERNARD AYBRAN, CHIEF INVESTMENT OFFICER MULTI-MANAGEMENT, INVESCO ASSET MANAGEMENT

What will be the main smart beta trends of 2018?
Similar to 2017, smart beta should remain a key focus in 2018, both for investors and asset managers. Though it has often been rebranded ‘factor investing’ as of late, the approach remains unchanged: diversifying away from traditional market capitalisation weighted investment.

Whereas it is unlikely it supersedes the geographical or sector approaches as the mainstream asset allocation tool, smart beta might gain some more traction for investors as a diversification tool.

Still, as is the case for investment approaches, some sort of trend following should remain, enticing investors to chase past performances.

Then, as some rotation should occur over the backdrop of a maturing cycle, flows might favour some other factors beyond the sole low volatility that has been dominant over the past few years: value and small-caps might be good candidates there.

Still nascent, the trend for a smart beta approach to the fixed income universe would be a logical next step: the current mainstream approach leads to owning more of the most indebted issuers, which is obviously questionable.

Last, from the providers’ perspective, i.e. the asset management houses, more fund launches are expected, primarily on a single-factor basis, before we can witness a much-needed consolidation.


WILMA DE GROOT, PORTFOLIO MANAGER QUANT EQUITIES TEAM, ROBECO

Is smart-beta an appropriate product for retail investors?
I am convinced that it is a perfect fit as it enables investors to capture the excess returns of academically proven factor premiums at a relatively low cost.

We do understand that retail investors need to get more familiar with these rules-based strategies – where the role of a quantitative fund manager differs from a fundamental one – before they start to embrace them like institutional investors have done. But probably this will just be a matter of time.

Often challenging for retail investors might be the selection and timing of the right set of factors and dealing with the unrewarded risks that certain factors possess.

For example: the momentum factor offers appealing return-risk ratios in the long run but is also known to be very sensitive to broad market reversals.

As a consequence, we see most retail investors opting for proven integrated multi-factor approaches with low relative-risk levels like enhanced indexing. These strategies enable

retail investors to get well-diversified exposure to the factor premiums while they don’t have to worry about the selection of the right set of factors, unknown factor risks or timing issues, as their fund manager, supported by research analysts,  will take care of all this.


IAN ASHMENT, HEAD OF SYSTEMATIC & INDEX  INVESTMENTS AT UBS ASSET MANAGEMENT AND BORIANA IORDANOVA INDEX  ANALYST AT UBS

What are the main trends you are following around smart beta investing?
Clients are demanding their index assets work harder for them. Consequently, alternative (‘smart’) beta strategies are advancing to meet these requirements.

Factor/index blending remains a popular trend: combining alternative beta indices capturing different equity factors (for example, pro-cyclical with defensive) can be highly effective at potentially reducing performance cyclicality and producing diversification benefits.

Investors interested in more customised rules-based solutions tend to opt for proprietary multi-factor strategies that aim to isolate the targeted factor exposures. As alternative beta popularity grows, so do concerns that these strategies are becoming crowded trades.

Evidence on this topic is mixed. We think such risks can be mitigated by constructing proprietary rules- based portfolios. Finally, a comment on sustainable investing and its intersection with alternative beta.

Clients are increasingly searching for solutions to combine esg and risk premia factors. Advancement in technology and a growing body of research is allowing the construction of transparent, high-capacity, cost- effective rules-based strategies that incorporate esg and equity factors. One of the key advantages of such strategies is their high degree of customisation, given the multi-dimensional nature of both ESG and equity factors. The possibilities of customisation in this regard are virtually endless, just as client requirements are.

©2018 funds europe