To avoid such problems, he recommends investing with asset managers experienced in selecting and combining multiple smart beta factors and focusing on efficient execution.
“Trustees should concentrate on the big mpicture – how much diversification will be added to their portfolio,” he adds. “They should leave the details of the specific factor choices to fiduciary managers or asset managers.”
Other potential problems include timing, where investors try to pick the right moment to buy and sell such factors. As seasoned investors will know, such strategies prove difficult to achieve.
Then there is overcrowding, which is when too many investors look to invest in the same factors.
This is a concern for Glynn. “There is mounting evidence that this is causing distortions in some parts of the markets.” This is something he considers when selecting managers to run these strategies.
But crowding of individual factors is not one of the main concerns among the clients that Peach has spoken to have. He says that he has been asked questions about whether or not these strategies have the capacity for billions of pounds of investment from institutions. “As long as the index has been constructed in a certain way within the rules that means that it can cope with the capacity, then capacity is not the problem. As long as they remain liquid then in the main they have been able to get comfortable with that part of it.”
THINGS TO COME
The only smart beta products that Peach is comfortable to recommend to clients are those where the index has been constructed appropriately and has sufficient real world constraints around capacity and liquidity. “Then there will not be a problem,” he says. For Peach the construction is almost as important as the factor.
“Market cap is just one way of constructing an index and nobody said that has to be the right way,” he says. “If you have bought into the fact that there is a smarter more efficient way then you should sever ties with the market cap index because you have made a fundamental investment belief that you don’t think that this is the best way to measure your investments.”
The general vibe is that smart beta is to become more and more a common feature in the portfolio of pension funds going forward. The question is what trends will shape the future of the industry?
Peach expects to see a continued focus on environmental, social and governance issues, collectively known as ESG, just like in many other markets.
“That is not to say that ESG will be included as a risk factor to be rewarded for,” Peach says.
“That might be a factor in future. But in the same way that the investment in normal equities, ESG is becoming a big focus and that will be true here and products will evolve to cater for that need.”
The market appears bullish on smart beta, so trustees and investment committee members should not be afraid of researching new ways of investing if it removes the minefficiencies of a passive mandate.
