PERFORMANCE: A balancing act

JugglerLow volatility is the best-returning factor of recent times and value has performed lower for longer than many might think. Alix Robertson looks at smart beta results.  As the smart beta universe continues to expand, new developments and further sophistication of products is growing.  In the report Smart beta: 2015 global survey findings from asset owners, index provider FTSE Russell found that European asset owners with $10 billion (€8.9 billion) or more in assets under management are leading the adoption of smart beta.  In addition, the use of smart beta products is becoming more complex, with asset owners on average evaluating four different smart beta strategies. As well as exploring multiple approaches, more than 70% are using a combination of different smart beta strategies. Despite this expansion, performance at single factor level remains significant in understanding the market. Over the past year, Sunjiv Mainie, head of research and design, Emea, at S&P Dow Jones Indices, sees low volatility as the factor showing the strongest consistent performance across all regions.  “There have been bouts of volatility within the markets over the last year,” he says. “If you look at what’s happening in the Ukraine at the start, and more recently China and over the last three or four months or so with Greece, I’m not surprised that low volatility indices have performed well.” In contrast, he identifies value as the factor that has performed poorly. “This is not just something that has happened over the last year or so. If you look at longer-term periods, going out as  far as say ten years, value has been lagging other factor-based indices.”  Of the factors sitting in the middle, quality stocks have done fairly well, he adds. “Quality seems to have performed particularly well in the European region and fairly well in the US region.” Eric Shirbini, global product specialist at ERI Scientific Beta, the Edhec-Risk Institute initiative that focuses on smart beta design and implementation, draws attention to the group’s recent work in which the quality factor is redefined.  In the past six months, ERI Scientific Beta has introduced two indices focused on high profitability and low investment, which Shirbini says are “a much more effective way of investing in quality”.   He expects these factors to gain further popularity with investors in the coming months and notes that, year–to-date, the high profitability factor (companies with strong profit margins) has outperformed the market-cap weighted index by 2.09%. In comparison, the low investment factor – companies that tend not to reinvest a lot of their earnings – has been flat compared to market cap-weighted indices. Generally, Shirbini says, low investment companies are conservative with a very high cost of capital and they can provide a higher return over the long term.  In line with the market’s growing sophistication, another focus at ERI Scientific Beta is the rise of multi-beta and, most recently, multi-strategy products. According to the June monthly performance report for the ERI Scientific Beta indices, the best performing index in the developed world universe compared to the broad cap-weighted index was the SciBeta Developed Low Dividend Yield Diversified Multi-Strategy index, with a relative return of 0.40%. MULTI-STRATEGY
ERI Scientific Beta also offers multi-beta multi-strategy (MBMS) indices, combining a choice of weighting scheme with an allocation to well-rewarded smart beta factors, to prevent indices from being too concentrated and to reduce their specific risks.  Over the past ten years, two MBMS indices – one being equal-weight and the other an equal risk index –have posted strong annual relative returns of 1.66% and 1.56%, respectively, compared to cap-weighted indices. Year-to-date, the best performer of all the MBMS indices is a UK index, with a relative return of 3.17% for the equal weight scheme and 2.90% for the equal risk scheme compared to the broad cap-weighted index. At index provider MSCI, a multi-beta or multi-factor approach is also a recent focus. Alain Dubois, managing director at MSCI, says: “Since there is some uncertainty in the market, I would not want to focus on one specific factor and I would prefer to combine them in order to diversify.”  He says institutions are moving from an initial interest in single-factor indices towards a multi-factor approach.  “[The factors] behave in different ways; they don’t react to the economic cycle in the same way, so there are some diversification benefits,” he adds. “We see multi-factor as really the hot topic at the moment.”  This summer, asset manager Lyxor joined with JP Morgan to offer five ETFs listed on the Xetra exchange and designed to capture the low size, value, quality, low beta and momentum factors within the European equity universe. The firm is also planning to build multi-factor products into its offering.   The ETFs use JP Morgan smart beta indices and have been back-tested to January 2000. Four of the five core equity factors have outperformed the MSCI Europe year-to-date (YTD), with the low size factor offering the strongest performance of 18.82% YTD, followed by quality at 16.83%. James Waterworth, vice-president, UK & Ireland institutional ETF sales, says: “The value factor has underperformed owing to uncertain economic growth expectations, whilst the low size factor has been driven by the illiquidity premium and the quality factor has been supported by investing in robust names.” He adds that, looking forward, Lyxor has the ambition of building a complete factor allocation platform, including both single factors and multi-factor ETFs. This will be initially focused in Europe with the intention of building out a global offering. (Amundi, another ETF provider, is also offering multi-factor investing, see pages 22-23 for more on this topic). BENEFITS FOR ACTIVES
At JP Morgan, Yazann Romahi, a smart beta portfolio manager, says that this expansion of the smart beta universe has benefits not only on the passive side but also for active management.   “When we think about factor-based investing specifically what you’re really doing is breaking down the asset classes into the underlying sources of return… Essentially you are broadening the universe that an asset allocator can use or take views on and of course breadth in the most important thing that an asset allocator has.”  At S&P Dow Jones Indices, Mainie also says these developments in smart beta, which are offering investors strong returns often with lower fees, are having a significant impact on active managers. “It is good for active managers; it makes them up their game,” he says. “I don’t see this as a bad thing for active managers; I actually think it’s a good thing for the industry across the board.” ©2015 funds europe

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