Smart beta – the future of multimanager and fund of fund investing? Fund managers are using smart beta strategies to improve the risk-adjusted returns of passive investment funds.
the National Treasury wants retirement funds to consider offering passive options as part of default investment portfolios. In draft regulations to amend the Pension Funds Act, National Treasury has called for consideration of passive funds in default investment portfolios as many people are automatically enrolled into retirement funds as part of their employment benefits package, but are often invested in inappropriate portfolios. They may also be paying higher charges than necessary. By encouraging investing in passive funds, portfolio managers are looking at the most effective ways to ensure they improve risk-adjusted returns. One such strategy fund managers are considering is what is known as smart beta.
Smart beta, a term being used more frequently in investment circles, can offer numerous benefits to investors. “Beta” refers to volatility or systematic risk arising from exposure to the overall market, which is quantifiable and measureable. A market capitalisation index product that offers exposure to the South African market as a whole would be referred to as a beta product.
Smart beta is a way of taking various systematic risks in the market and isolating them in order to use them more effectively in portfolio construction to reduce risk or enhance returns.
Says Len Jordaan, head of exchange-traded funds at Stanlib, who is driving the group’s smart beta products: “For example, you can construct smart beta to give investors exposure to high-dividendpaying stocks.”
Another option is to create a smart-beta product that provides exposure to low-volatility shares.
Smart beta is essentially a low-cost alternative to common active management strategies, but importantly, it is most effective when used in conjunction with active management as a balancing factor for an overall portfolio, hence its usefulness for portfolio managers.
Money managers construct portfolios by looking at the risk factors that are prevalent in their underlying managers’ portfolios. They take overweight and underweight positions in the underlying managers based on their overall view of the risk factors in the market. Every investment style, whether it is value, growth or momentum, has its time in the sun. There are periods when certain styles outperform or underperform the market. Sophisticated investors manage a risk bucket, allocating capital where they see the opportunity for the highest return at an appropriate level of risk, rather than simply chasing the highest returns.
The advantages for money managers of using smart beta within their portfolios are numerous.
Blending of factors
Smart beta indices create a very true and clinical representation of a risk premium, whether it is an index of low-volatility shares or high-dividend-paying shares. Rather than buying a general market capitalisation index, managers can choose an index with a specific risk factor exposure to use within their portfolio.
Stanlib’s Quantitative Investment Strategies team takes this to the next level by using a multi-factor process of combining risk factors to achieve the desired risk/return profile needed by the manager.
Says Teboho Tsotetsi, co-portfolio manager and quants analyst, who also forms part of Stanlib’s Quantitative Investment Strategies team: “We could have a client that is looking for exposure to a momentum factor. However our research has shown that despite the good returns over the long term, momentum stocks are typically very volatile and can experience huge drawdowns. In this instance, we would advise the client to combine momentum with something like
Smart beta is essentially a low-cost alternative to common active management strategies, but importantly, it is most effective when used in conjunction with active management.
Len Jordaan Head of exchange-traded funds at Stanlib