What It Takes to Go Smart Beta

Strong conviction, patience, and robust governance are required to implement multi-factor smart beta strategies, according to SSgA.

(February 11, 2014) — Advanced, or smart beta strategies have become a popular alternative to active and passive management of equities and fixed income, and cater to investors’ long-term goals with specific factor exposures, according to State Street Global Advisors (SSgA).

The asset manager surveyed 300 institutional investors and found 41.7% had already committed a proportion of their portfolio to smart beta, with 23.7% intending to commit. Only 17.3% remained skeptical of the strategy.

“It’s really not a fad,” Lynn Blake, CIO of global equity beta solutions at SSgA, told aiCIO. “Investors have been disappointed with active managers’ performance since the financial crisis and discovering great value in advanced beta’s transparency and its ability to help them achieve long-term goals.”

Blake said most criticisms of smart beta come from active managers who felt directly threatened by the strategy as they see big shift from the industry. Poor performance and high fees contribute to this change.

With fees similar to those of passive funds, smart betas have captured the hearts of all types of investor—corporate pensions were most aware of the concept, with public pensions following closely behind. Endowments and foundations were less familiar.

However, despite such interest, Blake said smart beta still had a long way to go, particularly concerning a multi-factor approach.

“It’s still in the education process,” she said. “Investors are still concerned about the time variance and how complex it looks on the surface, but they’re interested in being able to reduce short-term and cyclical risk. The multi-factor approach can help diversify exposures across factors.”

To date, only 9% of respondents said they had incorporated multi-factor strategies into their portfolios, SSgA reported. Sixty-five percent said they were planning to adopt the approach in some form.

“There are clear benefits to combining factor tilts,” Blake said in the report. “For example, valuation and volatility at times have negative correlation or very low correlation, so they can be combined and still may achieve strong performance with significantly lower risk.”

To implement such strategies, asset owners need to have a robust governance structure, the report warned.

“An asset owner not only needs to be able to identify long-term goals for the fund, he or she needs to have strong conviction to ride out short-term underperformance,” Blake said. “It’s about patience.”

The biggest hurdle asset owners face in implementing smart beta may be identifying who actually owns the investment decision, she added. After a firm decision has been made to implement such long-term strategies, whoever owns the decision must be able to get commitment from the investment board, CIO, staff, and other constituents.

“The point is to stick it out and not sell anything sooner than it needs to be sold,” Blake said.

Related content: Smart Beta Winning Fans as Volatility Fears Escalate  

By Sage Um