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Consultancy warns on risk naïvety in smart beta allocations

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Towers Watson has warned against smart beta products that are poorly implemented and show naïvety over inherent risks, as clients add $8bn (€7bn) to the asset class in 2014.

Describing its client allocations during the last year, the consultancy said 2014 inflows to smart beta strategies brought total client exposure to $40bn, doubling since 2012.

However, Luba Nikulina, global head of manager research at Towers Watson, warned against reckless allocations to the newly reinvigorated strategy.

“We believe smart betas should be easy to describe and understand, which many of these labelled products are not, as often they are poorly implemented and seem naïve about the inherent risks,” she added.

Towers Watson described growth in the strategy over the last five years as “phenomenal” and praised development of the fixed income market which is now where equity selections were in 2010.

Over 2014, Towers Watson clients added $1.5bn to smart beta fixed income mandates, triple the amount of inflows seen in 2010, which formed part of the $34.8bn in total credit within client portfolios.

“Unsurprisingly, smart beta innovation in the bonds space has been slower than in equities,” Nikulina said.

“[This is] partly due to the nature of the indices and the level of complexity which comes with the territory; but this is changing and we think that there is more to do in bonds.”

“Most investors in credit want to capture beta efficiently and improve implementation of thematic and tactical views.”

However, while innovations were slower, allocations are higher in value terms with $1bn of smart beta equity allocation, compared to $45m in 2010, and from a total of $20.6bn.

Overall, the firm also assisted clients in adding $10bn to alternative asset classes, a rise from $7bn in 2012.

Within this, $3bn went into real estate with around 10% into smart beta allocations, as $2.3bn was allocated to infrastructure – some 33% of which was smart beta.

The growth of the smart beta market has been well documented by research firms. Spence Johnson, an intelligence provider, said European investors would allocate a total of €211bn by 2018.

Annual inflows from UK institutional investors would be €15bn by 2018 and €29bn from the continent.

Research from State Street Global Advisers found 40% of investors in the US and Europe were allocated to smart beta strategies at the end of 2013, with a further quarter contemplating allocations.

For more on smart beta investing, read Martin Steward’s feature on the topic and see IPE’s upcoming March supplement

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