How has the smart beta sector evolved?

Eric Shirbini: Smart beta used to be a kind of catch-all phrase for many different strategies. One category of smart beta is where you simply aim at better diversification, so it is strategies like equal weight, risk-parity weights and so on.

The other category of smart beta is what has traditionally been called factor investing, and the idea here is to capture factors that are well rewarded over the long term. That is the original concept of smart beta that we saw about 10 years ago. Since then, we have built strategies that capture both of those elements in a single strategy, both diversification and factors to provide smoother returns through time. So that has been one evolution.

I think it is really important that people decide why they are going into these new opportunities so that they do it with their eyes open and know what could go wrong in this new space

Alan Pickering, Bestrustees

The second evolution has been combining factors, because factors are risky. And because they are risky, they are going to have a drawdown at one point in a cycle, so to diversify across factors can help you smooth returns through time.

More recently we have had other things, like incorporating these strategies with environmental, social and governance criteria and low-carbon criteria. On the defined contribution side we have seen more standard multi-factor products, but on the defined benefit side we have seen some customisation taking place as well.

Julien Barral:Post the financial crisis, low volatility was an area of focus for clients as they became conscious that an element of protection in their equity portfolio could be beneficial. The multi-factor conversation came about probably in the last four years, as people started thinking, ‘We could avoid crowding in some low-vol names, maybe add valuation’, trying to buy stocks that are not completely overvalued or using other factors to help outperform more consistently.

Pensions Expert: The investment industry is evolving smart beta beyond the equity asset class to focus on fixed income and commodities, for example. Do you see these gaining traction?

James Price: We have certainly found that if you are thinking about a pension scheme’s whole portfolio, there is only so much you can do. So you have to prioritise. And ultimately, the smart beta in equity, if it is a long-only strategy and it is fully invested, even if it is a real low-volatility approach, it is still going to lose money at the same time as the broader equity market.

So the ability to diversify into other asset classes is very appealing. One of the things that we have found smart beta has driven is more transparency and more cost pressures and value-for-money discussions in those areas that previously were less accessible and less transparent.

I think that a move to smart beta in other asset classes is really additive; having said that, it is not something everyone should go out and do.

Alan Pickering: It is really important that people decide why they are going into these new opportunities so that they do it with their eyes open and know what could go wrong in this new space, because they have left their own space as they were disappointed.

In terms of looking at debt in its various manifestations, if trustees are uncomfortable about having market-weighted exposure in the equity space, many of them are even more uncomfortable about having market-weighted exposure in the debt space, because some of those large debts might be toxic.

Shirbini: I agree with that. We can look at it also from a theoretical perspective. Factors are what drive the return of all asset classes. If that is the case, then perhaps people should align themselves more with factors rather than asset classes. It does not matter if it is hedge funds, equities, or any other asset class.

Now in terms of when you look at fixed income, you are investing in fixed income not just to get returns, you have different objectives – you might be trying to hedge interest rates. So if you then try to introduce the factor approach, it is more complicated in fixed income because you have to take a different objective into account.

I think the vehicles are there for small schemes, it is just do they have the time available to educate themselves sufficiently to be comfortable to get into it

Paul Black, Capital Cranfield Trustees

That is part of the reason why we think it has not been adopted as quickly in other asset classes and also because of information and data.

Barral: Fixed income in general – the data, the structure of the market, the number of issues – is more complex. Data availability has also been an issue, although improving. I also think that academia has not been as rich in terms of fixed income smart beta research. The combination of all this made it a lot slower to emerge on the fixed income side.  

Pickering: There are only so many ways you can extract value from the world’s economy. There must be a zero-sum game unless there is some form of alchemy that suggests that, with investors focusing on output characteristics from different market instruments, they can almost automatically improve the productivity characteristics of those asset classes and that is, I think, a big challenge. Politicians would argue it is easy – if only you invested where they directed then the world would be a much better place – but trustees are around much longer than politicians.

Price: I think that is a good point on the objectives and the zero-sum aspect. So the thinking about: should everyone try and do smart beta – in the same way, should everyone do active? It is a zero-sum activity. Smart beta strategies are active in the sense that they are not market cap; we cannot all be value investors at the same time in the same way that we can all be market cap and in fact, of course, we all are market cap investors in aggregate.

Shirbini: It is an important point to bear in mind that smart beta is not there for everyone. I think smart beta, or factor investing, is there for the long-term investors.

Those kinds of objectives, in terms of time horizon, are important, as are objectives in terms of fixed income; you need to bear all these things in mind.

Pensions Expert: What about smaller schemes, can they access these opportunities?

Shirbini: There is absolutely no reason why not.

Paul Black: The vehicles are there for small schemes, it is just: do they have the time available to educate themselves sufficiently to be comfortable to get into it?

There are plenty of vehicles from the old quant houses that have turned into smart beta houses, which is good for us as investors because they are now charging less for what might not be very different products.