Aon Hewitt's Tim Giles, Axa IM's Madeline Forrester, Nick Motson from Cass Business School, LGIM's Simon Midgen, the PPF's John St. Hill and Russell Indexes' Jamie Forbes discuss how to use smart beta strategies together, in the final part of a four-part discussion.
Jamie Forbes: We completed a survey in January of about 180 institutional investors across the globe, with just over half of those from Europe, and overwhelmingly the two strategies that investors said they had initially invested in were fundamentally weighted and low volatility. And what they indicated was that the next wave is getting a little bit more granular in specific factor exposures and being able to use those to control and manage risk more explicitly.
So whether that is through adding things like quality or momentum, it is all about how to intelligently combine these strategies in a way that will deliver or help achieve a best outcome.
Where investors need to be careful when combining strategies is whether that means they are overloading on some factors unknowingly
Jamie Forbes, Russell Indexes
Q. Is there a risk some pension funds could become overly diversified in smart beta?
Forbes: Where investors need to be careful when combining strategies is whether that means they are overloading on some factors unknowingly. If you have a fundamentally weighted index with a high exposure to value and are thinking about combining that with a low-vol strategy that also has a lot of value exposure, then are you comfortable doubling up on that factor?
Simon Midgen: We are definitely seeing this as well. So now, from having looked at value, or maybe a little bit of momentum with volatility strategies, we are being asked how clients can combine these strategies and what the characteristics of those portfolios are. And that is where, again, the smart beta approach can provide a whole new framework for investors to try to understand how they can meet their individual objectives, because they are different, whether it is a derisking approach or whether it is taking more or less risk than they would take in their benchmark.
And combining them together has certainly some interesting implementation challenges; you combine maybe a low-turnover index with a high-turnover index – how do you make the best of ensuring that, overall, the turnover and your transaction costs when you implement are still low? So those are becoming interesting, but it is definitely a new trend.
How do you make the best of ensuring that, overall, the turnover and your transaction costs when you implement are still low?
Simon Midgen, LGIM
Forbes: But at the end of the day, there is not an infinite number of risk factors out there. There are probably relatively few that investors have conviction in that will add value, reduce risk, help them achieve their objectives. So there is a happy medium in there somewhere.
Nick Motson: In fact, probably the only new factor anyone has mentioned in the past 10 years has been quality. We have had momentum, value and size forever, and low volatility – but it is interesting you mention the quality because we keep getting asked lots of questions about that.
And people seem to have shied away from the momentum because of what you said earlier – high turnover. When you actually try and implement it, a lot of it disappears, but if you combine it with other things you may reduce that turnover.
Midgen: Absolutely. So, for example, if you are looking for a higher risk-return profile than market cap, yes momentum will get you a long way there, but so will other strategies as well. Value will get you part of the way there, so by combining it you may be achieving a more practical, more implementable solution just in that scenario.
John St Hill: It is funny, though, that people are re-levering on momentum in long-only funds, but they are de-levering on momentum in hedge funds. Some of the momentum following hedge funds have underperformed recently, but funds which have had really strong plays in the last couple of years have been the ones that are running short-term momentum models.
So with regard to your point about people not buying momentum or not being particularly enthusiastic about it, it is curious that they are selling it in one place and buying it back elsewhere. Maybe, it’s a case of smart marketing.
Motson: Maybe it is a better place to buy it.
St Hill: Yes, maybe they are saying that is a cheaper place to get it or a more effective way to get exposure.
