EDITORIAL

Smart beta: where is the value?

Investors were paying active fees for that knowledge, and a tilt towards a style premia, but what smart beta now demonstrates is that knowledge is not necessarily skill.

I’ve been contemplating the “smart beta” wave the industry seems to be riding at the moment. Cynically, part of that contemplation asks whether there is any innovation at play or whether it’s simply the industry playing with nomenclature once again.

The answer is confusing, for while I’d like to be able to write it off as some sort of marketing game, there seems to be some real benefit to the end-investor of this smart beta trend.

Whenever a journalist contemplates something, it means a lot of research and part of the way I research is by talking to people. On this issue I’ve sought the insight of many people close to the trend – academics, investors and service providers.

Of those service providers whose opinion I value, State Street and AQR rate up there.

It’s not my usual practice to name service providers, in fact I don’t really even like writing about them, but the reason I rate them, and this is not exclusive, is they have a direct link with academia, applying the latest thinking to practice. And this is true of the thinking around smart beta.

If flows are anything to go by then this so-called wave is real.

The S&P Low Volatility ETF had flows of $2.5 billion in 12 months and now has the most assets under management of any ETF.

Similarly, the trend is demonstrated in State Street Global Advisors’ flows, while the bulk of it’s $1 trillion in global passive equity remains in traditional core cap-weighted indices, last year 40 per cent of its institutional inflows in this part of the business were into smart beta.

Smart beta defined

The definition of smart beta can be broad. Lynn Blake, global chief investment officer of SSGA’s global passive equities business, says it is an “objective, consistent, transparent measure of achieving some investment exposure”. In academia, smart beta really started about 10 years ago with fundamental indexing, ballooning as a topic of research, and now weighting portfolios by risk characteristics, such as volatility, has become the mode du jour.

It can be distilled into the fact that empirical evidence shows that there are certain factors that drive returns. These include price to valuation, low volatility, size and momentum.

Smart beta is implementing that thinking, so a portfolio is tilted towards one or, in the case of AQR’s products, many of these factors. AQR identifies four styles of premia – value, momentum, carry and defensive – and combines them in seven different places including industries, countries and currencies.

The benefit to investors is that the veil is being drawn back on what were often previously thought of as active strategies, so now investors can see whether there is really manager skill involved and whether it’s worth paying for.

Many active managers figured out years ago that value and momentum were drivers of return. Investors were paying active fees for that knowledge, and a tilt towards a style premia, but what smart beta now demonstrates is that knowledge is not necessarily skill.

The development of academic thinking and tools, and the application of it, is providing clarity around alpha, or the lack of it, and hopefully more transparent and fairly priced offerings.

The age of style tilts

While I think I’m convinced that alpha does exist, I know that tilting towards, say, value, is not it. So investors shouldn’t pay an active fee for that.

I must add, however, while I see an eventually bright future in product development and appropriate pricing, I also see a plethora of products about to explode onto the market, which investors will have to wade through to get to any eventual Mecca.

Apparently there are now already as many indexes as there are stocks, and we haven’t even really started on style-tilted indexes, not to mention combinations of style tilts.

As this new wave of industry development continues, investors have a chance to make some demands. Expect innovation, expect transparency, expect to pay appropriately, and expect honesty. If you don’t get it, don’t do business with those organisations. It’s simple really.

© Copyright: Whole articles from this website and newsletter cannot be reproduced without permission from the editor. If you wish to publish introductions to any article please ensure that it links to original content site www.top1000funds.com.au, and that it shows clear attribution to Top1000funds.com, plus author name and date. Failure to abide by this request will be considered a breach of copyright and legal action will be taken.

 
  • Filter:
  • News

    Intelligence on up to the minute items from around the globe

  • Investor Profile

    Behind the scenes summary of large institutional investors’ investment strategy and future plans

  • In Conversation

    Candid conversation with the leading investment experts

  • Analysis

    An in-depth examination of the latest investment trends and ideas

  • Insider

    An editorial perspective on what affects the people and processes in this industry

  • Research

    Cutting edge academic and practitioner insight

How to estimate the equity risk premium

Given the importance of equity risk premium, it is surprising how haphazard the estimation of ... [more]

Better beta bets pay off for UTAM

The $6.6 billion University of Toronto Asset Management made some significant active tilts last year ... [more]

Are there enough credit opportunities to go around?

Investors are all talking about the same thing –that alpha will come from selective opportunities ... [more]

Integrating ESG in private equity

The PRI has launched a guide for ESG integration among general partners in private equity,  ... [more]

UPS pension fund’s opportunistic future

The United Parcel Service corporate pension fund is finalising an asset liability study this year ... [more]

Risk parity and beyond

This paper analyses whether the use of uncorrelated underlying risk factors, as opposed to correlated ... [more]

What consolidation means for the AP funds

The five Swedish AP buffer funds will be reduced to three, a new responsible body ... [more]

Predicting equity returns with rising rates

The impact of higher rates on equity returns is a concern for investors and to ... [more]

The power of innovation

From allocating assets in order to achieve a healthy funding status, to keeping up with ... [more]