Waste not, want not
Judge’s comment: “Incredibly impressive smart beta programme built on a solid theoretical foundation, while its implementation is cutting edge with outstanding results.”
Smart beta investing is an important element in SEB Pension’s portfolio, inspired by the Arbitrage Pricing Theory framework published in 1976 that identified multiple return-drivers then separated them into categories based on their attributes, such as alpha, market components, and their systematic and structural premia.
SEB Pension thus splits its smart beta exposure into structural and systematic beta groups. It defines the structural component as investment opportunities that may arise from market frictions such as regulatory reforms, costs or other asymmetrical occurrences, while it defines the systematic component as systematically harvestable premia that are either a compensation for risk or the result of behavioural biases.
Despite multiple ways to define and implement systematic smart beta strategies, SEB Pension implements every return driver separately, as a dollar market-neutral long-short strategy. The scheme believes that this approach is superior to smart beta weighting models because simply tilting the portfolio is much less transparent and difficult to monitor. By constructing delta-neutral portfolios for every systematic return driver, SEB Pension believes it is able to properly identify the risk premia it is exposed to and evaluate performance in an isolated manner. Moreover, the long-short approach enjoys greater benefits from short-selling underperforming securities compared to a simple underweight approach.
SEB Pension implements a wide spectrum of risk factors across all asset classes. In order to qualify for the portfolio, every factor must be empirically well-documented, robust over longer time periods and recognised by many independent researchers. The factors should be explainable by underlying economic circumstances and should be persistent, trending positively in the long-run. Finally, each strategy should be implementable and scalable in terms of size, short-selling and liquidity.
Within the five major asset classes of equities, fixed income, currencies, commodities and credit, SEB Pension has identified a universe consisting of more than 30 factors that all satisfy these criteria. Each factor is implemented with minimal exposure to other factors or traditional asset classes. Strategies are implemented based on simple, dedicated and consistent signals that are easily observable and interpretable. Portfolios are rebalanced to reduce tracking error and mitigate costs. As risk premium performance can vary depending on time horizons, the factors are implemented in a diversified portfolio to optimise both long and short-term performance.
Inspired by Robert Merton’s Financial Services Alpha, structural betas are defined as arbitrage-like investment opportunities that may arise as a consequence of market friction and heterogeneous investment opportunities. The notion is that friction affects prices and that lightly regulated investors may take opposing positions as a form of arbitrage to benefit from the price inefficiency this creates. Opportunities are likely to occur in markets with asymmetrical regulations or in markets that are dominated by investors that typically buy or sell as a matter of course.
According to SEB Pension, pension funds have a natural competitive advantage in structural arbitrage. Since SEB Pension has ample access to debt financing, it is able to exploit leverage constrained investor inefficiencies. Moreover, it has the capacity to provide liquidity rapidly. At SEB Pension, structural arbitrage is a multi-asset strategy. It runs a derivatives overlay strategy for fixed income, currency, credit and equities. Positions are taken to harvest risk premia and exploit structural supply and demand imbalances in the derivatives markets. The purpose of the overlay portfolio is to allow SEB Pension to benefit from general opportunities in the markets and take positions that a truly unconstrained investor can acquire in a market driven by regulation and other causes of market friction, especially in today’s markets where investment banks are increasingly reluctant to get involved as a result of tightening regulations and capital charges.
Founded in 1872
Defined-contribution multi-employer pensions company
- active: 208,000
- retirees: 53,000
- one year: 12.9%
- Smart beta strategies based on systematic beta and structural beta
- Systematic beta relies on 30 factors covering five key asset classes
- Structural beta relies on price inefficiencies and short-term opportunities
- FRR France
- Pension Protection Fund United Kingdom
- Tim Giles
- Felix Goltz
- Andreas Hoepner
- Nick Motson