Merseyside impressed by smart beta, strategy not a 'silver bullet'

Peter Wallach, head of pensions at Merseyside, told delegates at the National Association of Pension Funds' local authority conference this week that its European minimum variance portfolio had outperformed the market cap-weighted index by 1.5 per cent a year over the past five years, despite a series of market falls.

“We think it’s more helpful to preserve capital rather than participate in market falls,” said Wallach, adding that volatility within the portfolio had been 25 per cent lower than the market cap index over the past six years.

“We funded at the wrong time – in March 2009, right at the bottom of the cycle,” he said. “But in 2011 when the market was down 14 per cent our portfolio was only down 4 per cent.”

We think it’s more helpful to preserve capital rather than participate in market falls

Peter Wallach, Merseyside Pension Fund

Merseyside’s minimum variance portfolio is managed actively across non-correlated low and high-volatility stocks. 

However, Wallach said he did not view smart beta as a “silver bullet” strategy, but that it had a place in the scheme’s broader portfolio.

“We will make greater use of it in the future,” he added.

Multi-factor approaches

Ana Harris, portfolio strategist at State Street Global Advisors, told delegates a multi-factor approach combining smart, or 'advanced', beta strategies had gained traction with pension fund investors. 

She said investors could diversify their returns by implementing several factors within a single strategy.

“We’re trying to get that diversification, a smoother risk/return profile over time, in the same way investors used to use multiple active managers in their portfolio,” she said.

“Combining factors into one portfolio hopefully smooths some of the bumps in the road as you go along,” she added.

A global survey of 214 asset owners by index provider FTSE Russell, published this week, showed the use of multiple smart beta strategies had increased over the past year.

It showed that in 2015, 71 per cent of respondents were using more than one smart beta strategy, compared with 59 per cent in 2014.

However John Pantall, member of the Greater Manchester Pension Fund board, questioned the levels of transaction charges that schemes might come up against when using a multi-factor advanced beta approach.

"For the local authority funds, we've been under a lot of pressure from our sponsors in government about costs and they have looked at transaction charges... I just wonder about charges," said Pantall.

Harris said such strategies tend to have a higher turnover than the standard cap weighting due to regular portfolio rebalancing.

“There will be higher charges and you must look at these things with a cynical eye,” she said, adding, “But active manager turnover is equally high."

Future in fixed income

Helen Forrest, the NAPF's defined benefit policy lead, who chaired the session, asked panellists how a smart beta, factor-driven approach to investing in equities could be applied to fixed income investing.

Harris said she had seen a lot of strategies starting to develop in the fixed income space, but thought it would be more difficult to back-test strategies in bonds.

“In contrast to equities, where there are more data sets [and] areas for testing… it’s harder to do it in fixed income,” she said.

“But that’s not to say there aren’t factors,” she added.