What drives the appetite for smart beta among UK pension schemes?

Julien Barral: In the UK, we have generally seen clients coming to smart beta from a cost perspective, as a way to reduce their overall fees, but also from a disappointment with their traditional active managers.

What you get with smart beta is an index strategy which is transparent

Eric Shirbini, Scientific Beta

Clients have been trying to find solutions at a reduced cost with a similar alpha potential, or slightly lower, but maybe more consistent factor exposures.

We have seen clients reconsidering their active allocation, keeping some traditional active strategies but splitting that and giving some to smart beta as well.

And on the active side, some schemes go even more unconstrained than what they were doing before, which altogether would still represent a cheaper or similar cost option. We have also seen smart beta replacing some of the passive exposure to make the assets work harder.

The structure the client already has in place will dictate what the change is or how smart beta will come into the portfolio.

Eric Shirbini: In terms of the main drivers, people are looking for more total returns.

But the other point we have not discussed is that what you get with smart beta is an index strategy that is transparent. Yes, you have to do a lot of homework. All the work is up front, understanding how they are constructed. Once you have got to grips with them you are able to see what you are holding. With active managers, you do not know what you are necessarily holding – so I think transparency is important.

The benefit of being transparent does not mean you just know the securities you are holding, but you also understand how the strategy is constructed, which means people can challenge your approach, which will ultimately lead to improvements. Furthermore, transparency leads to lower costs.

Paul Black: The way that I think about transparency in smart beta is you have a range of factors. I want to understand not just why each one has performed well in the past but what is the rationale for why it is going to perform well in the future, and that comes from one of two things. Either there is an economic rationale for it, or there is a behavioural rationale.

So just keeping an eye on those sorts of issues is important, but you are right: the transparency is there. At least you know what you are looking for, unlike the traditional active manager who might have a bit of style drift in terms of what exactly they are doing. It is very obvious in the smart beta space.

James Price: It may be that a small scheme is simply unable to get the transparency they want from a quantitative manager or other providers, but an index provider is very capable of doing that.

If you are a very large scheme then, certainly from our experience, the transparency level we get from those quant managers is comparable, if not pretty close, to what we can get from an index.

Alan Pickering: As a buyer, I want to know what I am buying and why, how it might evolve and whether I have any influence on how it evolves in terms of bringing in new factors and stopping using factors that no longer seem to work, and how I can get out of it at the end, not because it has performed badly but because it might not fit my needs. It is that sort of transparency I want. 

Pensions Expert: How has trustee understanding of smart beta changed with regard to education and training?

Smart beta is an area that trustees have looked into in more detail

Paul Black, Capital Cranfield Trustees

Pickering: I chair the Plumbing Industry Pension Scheme. Two years ago, our annual training day focused on alternative indexation, so we got the trustees to understand generically how the market was developing.

Then during the next year, we had a bit more training and the trustees implemented a package that did have unconstrained active management in many of the asset classes.

The first thing they bought – and it was something that they could get their mind around quite quickly – was alternative indexation that was no longer market weighted. It was squeezing out the extremes and the tails in a way the trustees could empathise with.

The trustees are now much more open to suggestions that there may be even more sophisticated ways of getting the best of both worlds in terms of beta and alpha, and if they can get the best of both worlds at a lower cost than they were paying before then that is a win-win.

Black: You come back to the age-old problem that trustees have so many things on their plate at the moment. We are talking about one corner of the investment world; trustees do not only have to consider investment, they have to spend time on their employer’s covenant, on actuarial issues, administration, all of those sorts of things.

We are all in a world where we expect investment returns, long term, to be a lot lower than we might have looked at five to 10 years ago, so wanting to sweat the assets a little bit more and keep fees as low as possible is even more important than it was before.

Price: We think about investment being a kind of perishable skill; if you do not exercise it, it dwindles, and obviously things move on as well, so you have not only got to maintain what you learnt a year ago at a training day, you have to also keep up to speed with new developments. It is not easy, but if you do not do that then it is hard to understand what it is you have actually bought.

Pickering: Trustees have been stung by the criticism that they cannot make decisions quickly enough. I find trustees now get very frustrated when they have made their decisions and those charged with the implementation seem to take an unconscionably long time to do so.

It really is important that the investment professional community focuses on project management skills and implementation because, although we are not buying fad or fashion, it is very disappointing to miss out on the first 10 per cent of a particular momentum if the people who are in the engine room behave even slower than trustees used to when making decisions.