What are the challenges of smart beta and factor investing? Factor strategies will have a profound impact on the way portfolios are constructed, says James Price, Investment Consultant at Towers Watson. “This impact will be felt throughout the entire investment process.”
Towers Watson advises institutional funds on a delegated basis. Price was one of the speakers at the Robeco Factor Investing Seminar in Rotterdam. We interviewed him after his presentation. “It may be difficult to observe correlated factor risks across the portfolio.”
Our view is that smart beta and factor strategies help asset owners to improve exposures in their portfolios to meet their goals. Smart Beta is a very broad concept with a wide impact. Part of this is ensuring operational efficiencies are realized, that the investment beliefs and strategies are in sync and that portfolios are reviewed on the basis of asset and factor allocations. It is also important that non-financial risks and sustainability factors are taken into account.
Improved exposures to meet their goals
The skillset required from a consultant to help the asset owner is evolving, because the type and structure of advice is changing. But this will not affect the broader work consultants do for asset owners such as risk assessment, strategic asset allocation, investment manager selection and delegated investment services.
When used appropriately, the application of factor strategies is definitely a positive. Considering factor exposures is a useful lens through which to view investors’ current portfolios and it helps to construct the portfolio they might wish to have.
Factor products within investor’s portfolios allow an asset owner to have factor exposure in a cost-effective way. In the past, investors may have paid high active fees for a product where performance was largely the result of exposure to one or more factors, something they were not aware of. Retaining that same exposure while reducing costs will benefit investors.
Useful lens through which to view portfolios
People will start to think more explicitly about the smart betas or factor exposures embedded in a portfolio, either through deliberate allocation, or as a result of their alpha-seeking active managers. The increased focus from consultants and asset owners on understanding exposures is definitely positive.
It helps to break down some of the boundaries that might have existed historically between different asset classes and opens up new ways to think about constructing portfolios. One might have a risk-premium starting point and allocate to factors and then select assets to implement those factors. So assets will no longer be the starting point for some asset owners.
It creates more options in terms of portfolio construction. That may give rise to new types of products which focus on delivering premiums across asset classes.
It depends on the beliefs and objectives of the asset owner, and how their organization is structured.
For some it will open up a totally different way of constructing a portfolio. It might lead to a need for more complicated strategies and their organizations will evolve. In other words: add the organisational capabilities to match with the investment process.
But for others, the primary drivers of the investment strategy will remain asset allocation, possibly because of their level of understanding or due to constraints by external parties. That might be a regulator or a third party that is providing them with a mandate to invest in certain asset classes. Any pursuit of a factor strategy will be within those constraints.
There are different challenges. One of them is making sure that the organizational capabilities match what is required to execute the investment strategy. As markets evolve some historic experiences of how parts of the portfolio will behave are no longer as relevant and that might be challenging for some existing organizational structures to manage.
For example, it may be difficult to observe correlated factor risks across the portfolio, if an organization is set up to focus on risk within different asset classes. If the future, organizations should be set up to observe and manage these risks.
Another challenge is the implementation. It is important to ensure that the right product is available and that there are appropriate implementation routes. For example, if you are a very large asset owner, you have the capability to implement customized accounts that meet your requirements.
Correlated factor risks across the portfolio
And if you are a small asset owner, you may choose to use these ready-made products to reduce the operational complexity, or you might be forced to do so because you lack the size for customized structures. In which case, a limited availability of pooled funds might restrict the ability to choose particular factors. But while large investors might be able to choose a customized solution, they face capacity and liquidity restrictions that a smaller investor may not face. In turn, that affects the strategies a large asset owner is able to choose and implement.
These are very important. They are one of the building blocks that enable an organization to deliver a long-term strategy. It is very important to have your investment beliefs and investment strategy in tune with each other. Then you are in the best position to make good decisions in the future. Where poor decisions are made, value can be destroyed.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.