Smart beta sets the pace for reform of passive investment sector
Robust debate is swirling around so-called smart beta – the indexation strategy – and poses the question whether this could be seen as truly transforming the investment scene, or whether it is just another marketing gimmick.
The passive investment sector has seen a surge of inflows since the onset of the global economic crisis, which has left active managers and even hedge fund mangers struggling to perform according to expectation.
At end of 2008, the ETF/ETP market in Europe had 853 products, with assets of just over $152bn, according to data from independent research and consultancy firm ETFGI. By the end of October this year, that total had more than doubled, to 1,928 products, with assets of $353bn from 45 providers on 23 exchanges. Of this total, 1,326 were ETF products, while assets accounted for $313bn.
But if the long-only funds sector is under pressure to reform and renew, so is the passive sector. As part of a general review of their passive investment strategies, investors have been turning away from traditional cap-weighted strategies and towards alternative indexation strategies, or ‘smart beta’, a controversial term.
Asset managers, consultants and investors are increasingly persuaded by the investment case for a ‘smarter’ approach to passive investment. A number of European pension funds have reallocated portions of their assets to smart beta, including the Danish Teachers’ Pension Fund, the Dutch PNO Media fund, and the Dutch Metalworkers’ fund. The UK’s Wiltshire County Council fund put 5% of its assets on Research Affiliates’ RAFI All World 3000 Equity Indices earlier this year. US equities Towers Watson has reported that £10bn of its institutional client assets have been allocated to smart beta strategies since 2007.
Xiaowei Kang, director of index research and design at S&P Dow Jones Indices, speaking at an event organised by Journal of Indexes Europe, says: “While traditional beta captures market and asset class exposures, investors are increasingly using passive investment vehicles to access systematic risk factors, systematic strategies or portfolio and risk solutions – which may be broadly classified as ‘alternative beta’.
Roger Urwin (pictured), global head of investment content at Towers Watson, which works with asset managers to develop smart beta strategies, describes indices as ‘a force for good’, taking business from long-only managers who lose their investors’ money. For Urwin, the main advantage of smart beta is they can be weighted according to risk budgets. As he says: “Systematic risk premium capture is what we are interested in.”
Smart beta is not just attracting money from long-only products. They can also replace hedge funds in investors’ portfolios, Urwin says, as “smart beta is not too far from hedge fund replication”.
Bruno Poulin, chief executive of Ossiam, agrees. “Hedge funds could reposition themselves as smart beta managers because they have the right core competences,” he says. Poulin should know. He speaks as a former hedge fund manager who has applied the research-intensive methods typical of hedge funds to the world of ETFs.
Alain Dubois of Lyxor Asset Management sees the smart beta fund manager as an asset allocator. He says: “Some ETFs are actively managed and therefore they have asset allocation. Some of our ERC [equal risk contribution] strategies are stockpicking-oriented, going deep into the stocks universe to select appropriate stocks.”
But the blurring of the once-clear division between fund manager and index provider is causing some concerns in the industry. By using a smart beta strategy embedded in an index, designed in collaboration with the index provider, fund managers are close to delegating the fund investment strategy to index providers, allowing index providers to enter the business of financial advice.