In the first of a four-part debate, 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 whether positive markets signal a good time to buy smart beta.
John St Hill: Part of what makes smart beta interesting is that it enables pension funds to control the key deterministic part of their costs, which is fees. And also it allows for better risk management, so I do not think there is a one-size-fits-all solution, but I think it does offer a greater range of tools and better tools for risk management.
Part of what makes smart beta interesting is that it enables pension funds to control the key deterministic part of their costs, which is fees
John St Hill, PPF
Tim Giles: There is a lot of trustee interest in smart beta, not all of which has translated into implementation. Where we are tending to implement is around strategies that align with the philosophy the trustees have – so for example, if they want lower volatility from their equities, minimum-volatility approaches are considered. So it is aligning the approach to what they think is the right way to invest in equities.
Simon Midgen: We are still in an evolution phase, the debate will continue and get more intense. We have moved from a point where these are interesting strategies and there has been, certainly from our perspective, quite a lot of implementation, particularly around value strategies.
Now you are seeing the evolution from index providers who are bringing out a wider range of tools that asset owners can consider, giving them greater flexibility to try and understand how those tools might be relevant in the context of their particular approaches – as well as to get their heads around what these different tools mean, which is part of the challenge as well.
Madeline Forrester: Given the broad church it is very difficult to say smart beta has underperformed or outperformed. Clearly minimum volatility will not have done well in that environment and that is where much of the demand has come from.
Nothing has fundamentally changed, and actually the performance of the last year probably means this is a good buying opportunity and schemes should continue to ask themselves whether they should be looking at smart beta.
Obviously not everybody would be attracted to an asset class that may have had some underperformance this year, but logically I think it is up to all of us to continue to talk about this topic and encourage people to take the opportunity of what might be a good entry point.
Nick Motson: I think you have hit two nails on the head there. One is that this stuff has got to be long term – all of these are harvesting some sort of long-term risk premium that we have seen work over decades. And the smart bit probably comes down to what you said about fees; it is smart packaging and it is trying to get people to understand these risk premia are there, and they can access them without having to pay somebody 150-200 basis points.
The danger is in this idea that people should be trying to time it. We cannot time the direction of the markets, so how are we going to be able to time the factors any better?
Forrester: Timing might be the wrong phrase, but at the same time, given it is a new asset class, when people look at a range of things the market environment should not prevent them.
Motson: The market has just done really, really well, and we know that low volatility is going to underperform in that environment – but if the market does badly next year then it will outperform. And [investors] have to be comfortable with that whole concept and that is why I think we should be looking at the long term and what their objectives are.
The market has just done really, really well, and we know that low volatility is going to underperform in that environment – but if the market does badly next year then it will outperform
Nick Motson, Cass Business School
Midgen: Is that not part of the challenge, though? It is challenging for any investor to take such a long-term view. It is going to be a brave person that is going to suffer what you have shown in some of your research, to have potentially years of underperforming.
Motson: Yes, if this had been launched 20 years ago it would have been stillborn because it would just have hit the massive raging bull market; it would have underperformed for the first five years. People have to understand that there are going to be periods of underperformance for certain strategies and periods of outperformance.
Giles: The trustees will benchmark it because they are driven to that type of approach. And they will often look at it against a market cap index, and that is where you come back to [the fact that] there needs to be some long-term focus rather than quarter-by-quarter, as it may not perform quarter-on-quarter.
Jamie Forbes: There is also the danger of painting it all with the same brush, calling all smart beta strategies the same. They do completely different things and will play different roles in a portfolio, and maybe there is a benefit to the combination of those strategies. But I do think it is maybe a bit dangerous to lump them all into the same category, and – back to your point of the definition – to be very clear about what is a factor index that targets a specific risk factor, a belief that it is a factor investors want exposure to, that it will persist over time versus something that takes the market cap index and weights it by something other than price.
St Hill: A lot of investors fail to realise that their capitalisation weighted index has a set of bets in it. Surely what people should do is, if they are going to take those bets, they should make an active decision to be aware of them as opposed to just inheriting them unknowingly.
Forbes: It is back to ‘what has changed?’, are the betas themselves getting any smarter or is it just our ability to see what is actually going on, what is changing or improving?
