Next-Finance: Last month, you have published a study showing strong interest in Smart Beta strategies. What do you really mean by Smart Beta (what kind of funds, strategies,…) ?
Philip Tindall : We use the term broadly to mean strategies that move away from a market cap approach in the main liquid asset classes (equities and bonds), which we often refer to as standard or bulk beta. Smart beta therefore covers alternative ways of weighting securities in these mainstream assets, investing in alternative assets or ‘risk premium strategies’ (eg momentum or carry) or capturing long term thematic ideas. In all cases, we aim to improve portfolio efficiency for our clients through better risk adjusted returns or portfolio diversity. Smart Beta is simply about trying to identify good investment ideas that can be structured well, and implemented in a low cost, straightforward and systematic way.
How do you explain this growing interest of institutional investors in smart beta strategies?
There are a number of reasons. The tech boom and bust, followed closely by the financial crisis, has led investors to question the standard finance assumption that markets are efficient – a thesis which supports ‘standard’ beta. There has been a decades old debate in academia, but it has now gone mainstream. In our view, markets are not perfectly efficient. Many of the arguments for smart beta make intuitive sense, and are well argued by their proponents. It is therefore easy for institutional investors to ‘get’ the idea. Secondly, the complexity and range of investment issues and choices faced by investors is daunting, and has mushroomed over the last decade or so. Faced with limited governance budgets, investors may choose to focus on alpha or beta as ways to improve efficiency. Both approaches are valid, providing they are done well in our view. We see Smart beta as a way to ‘do beta well’ with relatively modest governance. Lastly, there has been some disappointment with active management over the last few years, as well as greater attention on cost (internal and external).
We would say that not all approaches are equal, and careful evaluation for cost, complexity turnover etc is needed. Asset managers should have a well thought through, cost effective, product.
Philip Tindall, senior investment consultant at Towers Watson
What kind of Smart Beta strategies for what kind of institutional investors (pension funds, sovereign wealth funds and insurance companies)?
We see main factors as governance, risk tolerance / time horizon and liquidity, rather than investor type. We believe that Smart beta ideas require more skill from an asset owner than ‘bulk beta’ - the ideas are not mainstream or macro-consistent (all investors cannot move to Smart Beta without affecting prices). Asset owners need ‘skill’ to understand the investment thesis (both historically and looking forward) and to monitor its effectiveness over time. Institutional investors that have, or develop, appropriate governance can therefore take advantage of Smart Beta ideas. Secondly, some strategies have short or medium term risks - investors that can manage or tolerate these risks are better able to capture opportunities (risk premia) over the longer term. Similarly, investors who have some tolerance for illiquidity, can capture a premium from those investors who cannot.
Are the different needs depending on the geographical distribution?
The ideas can be used in all regions of the world, subject to suitable implementation options. Certain regions appear to have caught on to the ideas earlier however. In our experience, Australian institutions were early adopters of Smart beta concepts, for example. The ideas are gaining interest in most parts of the world now though.
How do you see changes in smart beta assets over medium terms and which asset managers are best positioned to benefit from this growth?
We see more growth in Smart betas strategies. There has been a lot of interest in this area, and investors are beginning to allocate assets - our own clients have invested more than £10bn. So far, most of the investment has been in non-market cap weighted equities strategies, and there are now numerous approaches (for example low volatility, risk weighting or fundamental weighting). We see further development of non-market cap approaches in bonds. We also this think there is potential for further development in so-called alternative betas (strategies investing in alternative assets or capturing alternative risk premiums – often classed as hedge funds strategies). We would say that not all approaches are equal, and careful evaluation for cost, complexity turnover etc is needed. Asset managers should have a well thought through, cost effective, product. We also favour simplicity and ease of understanding wherever possible.
