How Are Institutions Using Smart Beta?

Coverage of the 2014 Risk Management Conference.

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mouse trapWhen it comes to portfolio management, “it’s no longer about active or passive,” said Rolf Agather, managing director, research & innovation, with Russell Investments. Agather was speaking at the 2014 Risk Management Conference in Muskoka, Ontario, held from August 13 to 15. He believes the investment management industry is moving toward strategies that are more mechanistic, such as smart beta or quant.

Smart beta strategies differ from quant strategies in two important ways, he explained. First, they offer improved transparency. Second, they are rules-based and don’t really involve the use of judgment or discretion on behalf of the investment manager.

Exposures can be strategy-based (e.g., equal weight, risk parity, fundamental indexing, minimum variance) or factor-based (e.g., value, size, momentum, quality).

Why are institutional investors using smart beta? Russell’s Global Smart Beta Survey, conducted in April 2014, found that 63% of investors are turning to these strategies for risk reduction, while 62% are looking for return enhancement. Cost savings ranks at the bottom of the list, at just 15%.

“The motivation really is to improve investment outcomes,” Agather added.

He suggested three ways that investors can use smart beta in their portfolios:

  1. Design—as an alternative to market capitalization;
  2. Construct—as an implementation choice; and
  3. Manage—as an additional tool to re-align the portfolio.

The benefits of smart beta are having another tool in the investment manager’s toolkit and “getting more bang for the buck” as part of your total active risk budget, Agather explained. But he added the cautionary note that with increased capability comes increased responsibility.

“Just because you have the capability, it doesn’t mean you should necessarily use it.”

Alyssa Hodder is editor, Benefits Canada.

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