The growth in ‘smart beta’, or factor-based, investment strategies could disrupt traditional institutional funds management risk exposures, according to a new Russell Investments paper.
In the article published in the Winter 2015 ‘Russell Communiqué’, authors James Barber and Evgenia Gvozdeva point out new factor exposure techniques and tools “allow equity portfolio managers to capture strategic and dynamic beliefs in their positions with greater precision than has ever been possible before”.
“With the increasing attention paid to factor exposures among active managers, practices are evolving,” the article says. “Historically, institutional active managers tended to have, in aggregate, a positive exposure to momentum and a negative exposure to low leverage. Value, of course, has been closely tracked and is commonly used as a means of categorising active managers according to style.
“With the rise of smart beta and other evolution in investment management practices, those historical patterns may change as all managers become more conscious of their exposure to various factors and deliberate in their management of them.”
The article concludes fund managers can extract “a strategic return premium” from a ‘smart beta’ approach, with certain caveats: each of the three market factors – value, momentum and quality – Barber and Gvozdeva analysed are subject to “short term reversals”.
“… if implemented in isolation, [smart beta strategies] could lead to performance patterns that few investors could tolerate,” the Russell paper says.
“But taken together, and with dynamic management of exposures to capture cyclicality, valuation and sentiment, they allow portfolio managers an improved tool kit for adding long term return enhancement and managing shorter term risks,” the article says.
Barber also argues elsewhere in the Russell publication that ‘smart beta’ should be incorporated as a component of overarching “positioning strategies”.
He defines ‘positioning strategies’ as “any investment strategy or instrument used to align a total portfolio with a portfolio manager’s preferences”.
“The tools used to implement positioning strategies include a broad set of investment capabilities such as overlays, index replication, smart beta strategies, ETFs and custom quantitative strategies,” Barber says in the article.
He says positioning strategies can help investors in four areas by managing: strategic beliefs; dynamic positions; portfolio risks; and, liquidity.
Russell’s annual NZ investment conference is scheduled to take place this week in Auckland.