By Tim Gardener
Smart beta naysayers are all around, and one of their favourite complaints echoes Ecclesiastes. “There is nothing new under the sun” it says, and equally the naysayers claim there is nothing new about smart beta, that focusing on specific factors like value or small caps has been around for decades.
To some extent, this is totally correct. Many quant strategies at the turn of the millennium were smart beta strategies where returns were primarily factor driven. They were also shrouded in secrecy and lacked transparency. Fund managers did not want to reveal their proprietary model. This lack of transparency allowed managers to charge active management fees for what we now know were principally beta harvesting strategies.
But at the same time, this claim also totally misses the point. Most smart beta providers do not purport to have discovered factor-driven strategies. Instead, they are proud that for the first time investors can access these strategies cheaply and can expect transparency as to what drives return and volatility. Genuine smart beta strategies are priced at 15% to 25% of the price of the old fashioned factor driven active quants strategies and operate to a transparent rules based system.
It also ignores the fact that smart beta itself is changing, developing and evolving.
Wherever disruptive technology is introduced, the first generation is usually based on the object it replaces and built by manufacturers of the existing technology. The first motor cars looked like and indeed were called ‘horseless carriages’ for instance.
So it has been with smart beta. Early developments came from those with alternative indexes based on factors. Products simply shifted from tracking one index to another. While this has proved adequate, it has to some extent produced a different set of problems, such as short term cyclical performance, unwanted factor concentrations and costs from rebalancing.
The second generation of products often comes from a blank sheet of paper. New providers enter the market who do not have to worry about cannibalising existing business. It’s the difference between focusing on how to design a motor car rather than a motorised horseless carriage if you like.
None will be constrained by ‘how it was done in the past’ and all will focus on ‘how it should be done’. They may or may not track indices but the one commonality all should have is that all will comply with the four basic elements of beta harvesting strategies: that they are transparent, rules based, well diversified and cheap relative to alpha hunting strategies.
The smart beta opportunities available today are the first to offer investors access to these strategies in a cheap and transparent way. Those who say there is nothing new in smart beta don’t have to pay the fees. Asset owners recognise that in one area at least the fund management industry is delivering beta harvesting strategies at the right price.
Tim Gardener is global head of the Institutional Client Group at AXA Investment Managers.
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