How can smart beta best be used in the new DC default space?

Alex Koriath: In the alternative beta space, you ought to pick a strategy that you are confident has some empirical risk premium you can harvest over time – and one in which you can stay invested for the medium term to long term. 

Defined contribution, for most people, unless they are coming close to retirement, is a longer-term investment, so I can absolutely see why Nest is considering including such strategies in a default and why alternative beta could be considered for a number of DC funds.  

Stephen Miles: I totally agree. The time horizon for DC is naturally longer, from various perspectives, which makes it more suitable if anything. And there is the DC fee cap, which fits with smart beta being inexpensive. Also, there are sometimes clearer outcome-oriented goals for DC with certain risk profiles that you want to get.  

Koriath: It is probably important that, with someone like Nest using smart beta, DC schemes look into the governance aspects of these strategies because I think it will be very hard for the individual member to pick from, say, a number of smart beta funds and make a call. 

I think there needs to be some governance overlay – obviously that is there with Nest and with a number of other schemes – that looks at alternative beta strategies and how these can fit in a portfolio. So, for the individual member on their own, it will be quite tough to differentiate between different smart beta products.

The time horizon for DC is naturally longer, from various perspectives, which makes it more suitable if anything. And there is the DC fee cap, which fits with smart beta being inexpensive

Stephen Miles, Towers Watson

Ronan Kearney: Given that the cap, as I understand it, for the auto-enrolment space is going from 75 to 50 basis points for admin and investment, there is not a lot of room in there once you have paid your admin costs of 20ish basis points to buy active. So active is effectively shut out of that space.

Simeon Willis: Nest has been very innovative; I think it is right that they consider it, particularly given the charge cap.

I think there is a bigger challenge for the industry: should people have more lower-risk assets earlier in their accumulation phase? So the question of should DC investors invest in smart beta, I think, is fairly low down the list; I do not think it makes a massive difference to the outcomes for them.

I think they have much more bigger-picture priorities: how much are you saving; how much risk are you taking in aggregate?  

Maxine Kelly: Where will the next innovations in smart beta come from?

Koriath: I think it will be interesting to see, first of all, how the industry consolidates. There are a lot of products from a lot of different providers that look similar. How will the industry consolidate? What will the sustainable strategies be?  

It will also be interesting to see whether some alternative beta strategies are integrated or combined with active management and some hybrid evolves, where a smart beta starting point is put together and some elements of active management are layered on top of that.  

It will also be interesting to see whether some alternative beta strategies are integrated or combined with active management and some hybrid evolves

Alex Koriath, Cambridge Associates

Richard Hannam: The thing we have not spoken about at all is fixed income and what is going to happen there, because I have never understood why, as a company or a country becomes more indebted, you own more of it. 

I think what managers can do there in terms of better-weighting schemes within fixed income and what the underlying drivers are is an interesting thing. That is an obvious space, I think, for some new ideas and products.

Miles: There will be more, I think; it is just a matter of time. A lot of the parallels from equities you can apply to credit. 

Deconcentration can be applied at the group level or at the security level. You can also look at the quality, or low-volatility arguments, and apply them to credits. 

The other thing I have seen is work on the style factors, like value and momentum, being transposed across. I think research is behind, but it will get there.

Willis: In terms of the aggregate level of interest and asset flow, I see three economic scenarios that will have an influence. The central one would be a steady-as-you-go scenario, where take-up continues as we currently see and there is a modest move into smart beta with people buying into the appeal of the concept. 

You could have a scenario with strong performance of the popular factors. If we assume that, in general, some factors are synonymous with smart beta and those factors do well, you will have a herd rushing in to try and capitalise on that, perhaps a bit shortsightedly. 

If, conversely, we have the opposite scenario with losses, you will have people saying, ‘That really has not worked out how we were expecting,’ and largely knocking smart beta on the head and moving back to what they were doing before.

So it is very dependent on those scenarios, but it will be interesting to see how it pans out.

Miles: I think there will be at least one big change to the major factors as well. If you look back five years it was not the same group of five or six factors that are more commonly talked about today. Quality and low volatility used not to feature much. And if you look back 20 years, the factors were a bit different again.  

The challenge for the industry is going to be not making everything too complicated with many products. That is the danger we face and it could lead to a backlash.