Focus Group: Smarter than the average beta?
Over half of the funds responding to this month’s Focus Group survey currently allocate to investments that employ smart beta concepts, with an average of 17.5% of their equity portfolio managed in this way. Nine funds are considering further allocations.
A Dutch fund said: “Twenty per cent of our equities portfolio is allocated to low volatility and maximum diversification for risk reduction. We are adding another 10% to a combination of three risk factor strategies.”
Ten respondents currently employ minimum variance/low volatility strategies. A further seven funds are considering them. Seven use fundamental indexation, with four considering, and four employ maximum diversification/risk efficient indexation, with seven considering. Just three use factor-optimised portfolios, although 14 funds are considering the strategy.
Seventeen respondents are not currently allocated to smart beta, and 10 of these are not considering any future allocation. “We have a very clear investment strategy which, by diversity, covers the aspects which smart beta is designed to produce,” commented a UK fund.
A Dutch manager added: “We don’t believe in the concept. Smart beta sounds as if outperforming is easy by using a quasi-passive approach. In practice, we see that more than 50% of managers underperform (after costs).”
Among those that have allocated, most characterise smart beta as either a ‘smarter’ way of doing passive investment, or a cheaper way of getting active investment (as opposed to a useful way to create benchmarks).
Ten thought that it was essentially passive investing and two saw it as a benchmarking tool. “Smart beta is an active choice for a passive investment,” as one Dutch fund put it. Another said: “We do not agree [that] market cap [is] the default passive strategy – an equally weighted benchmark is just as good a default strategy.”
Among the nine who disagreed, there were some strong opinions. “Smart beta has nothing to do with benchmarks,” stated another Dutch fund. “A benchmark should follow the market. Smart beta strategies are, by definition, not passive. The market will overweight overpriced securities. Avoiding this problem in a systematic way, while keeping your eye on other risks that you might get by doing something different than the market, is a very responsible approach.”
A French fund was one of four respondents that saw multiple uses for smart beta: “Breaking down generic market beta into its true components allows for better passive benchmarked management, cheaper active processes and more relevant active management benchmarks.”
These attitudes inform the extent to which investors regard smart beta as easing their governance strains (by making active management more systematic) or worsening them (by turning one source of beta into many). “I don’t think it is smart to use all smart beta strategies – you have to limit yourself,” said the head of finance at a Swedish fund that invests in low-volatility strategies.
A Dutch fund felt it adds to governance strains, as “the regulator does not understand that a low-volatility strategy offers less risk by deviating from the market, instead of more”. A Swiss fund believed that as “using smart beta is focused on improving return-to-risk ratio, not just return; governance must be adapted to measure success on the basis of return-to-risk first, risk control second, and returns third.”
It is less of an issue for others: “In fact a temporarily underperforming smart beta index is less embarrassing for us than an underperforming active manager – if only because the fees involved are not the same,” said a French fund.
Seventeen respondents think the smart beta concept is readily applicable in other asset classes than equity. Four funds have allocated to smart beta products for government bonds, two each for corporate bonds and commodities, and one each for currencies and hedge funds.