Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Research Affiliates growing Australia: the implications
by Greg Bright
When Research Affiliates set up an Australasian office in mid-2018, it probably knew it would cause a stir. It agreed for Australian Mike Aked to go home to Melbourne to set up the new business. He is country head and head of research and strategy. He was the former head of asset allocation globally at Research Affiliates in the US, the firm which many people believe invented ‘smart beta’. This is a story which reflects the growth in the burgeoning low-fee, smart-beta world.
Research Affiliates set up its own index fund company in 2017, called RAFI Indices, but already had relationships with several funds management companies in Australia, and elsewhere, the most important of which, based on local headline numbers, was with Real Index, owned by the old Colonial First State Global Asset Management, which is now owned by Japan’s Mitsubishi UFJ Financial Group. That big manager has been renamed First Sentier Investors. Realindex Investments, an established subsidiary of First Sentier Investors with about A$26 billion under management, built up a significant level of staffing alongside its funds under management, and had a relationship with Research Affiliates. That relationship ended last year.
Real Index last month announced the addition of another senior manager, Ron Guido, who previously worked for the family office RF Capital. His appointment took the Realindex team to 14, of whom 11 are investment professionals, under long-time head of the business Andrew Francis. Research Affiliates has ongoing Australian and New Zealand relationships, after the Realindex separation. They are with: Parametric, an implementation-focused affiliate of big US manager Eaton Vance; State Street, the asset servicing firm and institutional fund manager; and BetaShares, the specialist Australian ETF provider and administrator. Guido has worked in the field of systematic investment strategies (smart beta) for more than 10 years, with big quant managers BlackRock and State Street Global Advisors.
Andrew Francis also announced last month that Realindex would be reducing its fees by cutting its buy-sell spreads and management fees of the retail ‘Class A’ funds it manages. Management fees for some funds would be reduced by up to 13bps, he said. “This fee reduction is the result of our business increasing in scale, creating an opportunity to pass fee savings to clients,” Francis said in a prepared statement. He declined to comment, with this newsletter, about the changed relationship with Research Affiliates.
Mike Aked says: “Our business model is to focus on our core business of investment research and the resulting development of product, and relying on partnering with firms to implement, or trade the strategies. It is our view that the world does not need another trading desk. We rely on our partners to do the bulk of the distribution work with the end investors such as superannuation fund members or financial planners. In Australia, we currently work with a range of partners including BetaShares, Parametric, and State Street in this manner.
“Australia is a fantastic market for our mission, which is to positively impact the investment community via transformative insights and products. And in many ways, the so-called smart beta approach is one of the largest transformation in the investment management industry that has occurred this century. Our primary business is to take academically rigorous, vetted, and robust return drivers and apply them with disciplined and repeatable processes in a cost-conscious way where more of the benefit accrues to the end investor. Our mission is to add value to the end investor by focusing on robust investment strategies, cost-conscious implementation, and low fees.
“Since our founding, we have maintained a team to bring our ideas to large asset owners and consultants. Indeed, some of the earliest fundamental index investors in the US worked directly with us. A lot of our research is founded on the premise that one of the primary sources of adding value is to stay invested. We spend a majority of our time supporting investors to this end. Most recently, our deep dive research with Rob Arnott and Professor Cam Harvey is to look into data behind the underperformance of value on a global basis. We test the stories that are being touted, and most come up short. Investment markets are currently in a very unique and interesting time and we wish to bring thoughtfulness, robustness, and sanity to the discussion.”
He said the Research Affiliates approach was to bring the full array of our product line and research to the Australian investor is an expansion of the firm’s global reach. “We opened an office in London, supporting our European business in 2014. We think it is time to replicate our success there in an important market such as Australia. We look forward to Aussie adoption of RAFI Indices across fundamental index, multi-factor and ESG offerings.”
RAFI stands for Research Affiliates Fundamental Index. The firm was started by Rob Arnott in Newport Beach, California, the home of PIMCO and several other big global funds managers, in 2002, building out quant-based strategies which blended fundamental investment factors with traditional market-cap indices. There are about US$145 billion in assets managed around the world using its information and strategies. Its success would make the late great Jack Bogle (founder of Vanguard and champion of market-cap indices) turn in his grave. Adam Willis joined Research Affiliates in Sydney in September last year to head up the client-facing efforts in Australia. An Australian, he previously worked in London at Legal & General Investment Management.
Aked says: “We are a research driven firm. In other words, what’s “next” is where the research takes us! One of the advantages to our scale and global presence is our ability to take research from one geography to another. We’re relentlessly curious. So, I am having a lot of fun in two ways: First, I get to take our research undertaken by my colleagues in the US and Europe and test it in the Aussie market. Second, I am taking great questions from Aussie clients and interacting with my colleagues in the US and Europe to arrive at better outcomes.
“Today, much of our work is helping investors navigate current and timely investment debates such as the purported death of value investing. More recently, we have been looking at the performance of factor portfolios across both the stock market cycle, as well as the economic cycle. We have generated, and managed factor portfolios for over 15 years, and we have data across all geographies, definitions, and periods. This enables us to do academic quality research across a very broad range of suppositions.”
Chris Briant, the head of Parametric in Australia, as well as the head of its local affiliate, Eaton Vance, says his firm adds value to ‘RAFI portfolios’ through its specialist implementation services, including better after-tax management. Parametric currently implements about A$15 billion in Research Affiliates strategies globally. A research report by Raewyn Williams, Parametric’s Sydney-based head of research, published last year, shows that the firm can add an average of 53bps to annual returns from a RAFI index on an after-tax basis.
Briant says he greets the Research Affiliates initiative to grow a direct local presence and push harder into the Australian market with excitement. “We stand ready to implement those strategies here as we already do around the globe. In Australia we mainly expect to implement them for super funds where our implementation lifts after-tax returns and improves retirement outcomes for members,” he said. “As a specialist implementation manager, Parametric provides custom after-tax focused implementation of passive, factor, smart beta and active management strategies. No matter where a Fund sits on the passive to active (investing) spectrum, Parametric can help – not just with tax efficiency but also all other aspects of trading and implementation – for the ultimate investors’ benefit.”
The popularity of factor investing, using smart-beta strategies, has raised questions about how the investment style should be defined. Aked says there are three main requirements of a factor:
- Factors should be grounded in long and deep academic literature. These studies should include what Cam Harvey calls the “economic plausibility” of why the factor can be expected to produce an excess return
- Factors should be robust (i.e. statistically significant) across definitions, and
- Factors should be robust across geographies.
“Through these lenses, we find that the number of verifiable sources of systematic return is very few. As most aspiring PhD students have shown, the hurdle for ‘academic significance’ can be very frequently passed by adjusting the time-horizon, geography, or definition of a factor. If we adjust all the factor findings for multiple tests, a core tenet of both Research Affiliates and our director of research, Professor Cam Harvey, we find value, low beta, quality and momentum appear to pass. This makes us unpopular in many fields, but we are willing to invest our own and our clients’ money on it. So, our answer is ‘four’!”
Fee compression had unquestionably, been a driver in the popularity of smart beta. The move to low-cost investing is a good thing for super fund members, Aked believes. And it’s broadly been a good thing for Research Affiliates. Systematic rules-based strategies have a variety of inherent advantages. They can access the factors above with low management costs, low transaction costs (if designed properly) and low governance costs.
“I think we are going to find that the ability to hire and invest with good active managers is going to become harder as time passes,” Aked says. “…As a measure, the majority of active fundamental managers in Australia have underperformed a simple rules-based value strategy over the last decade. From the majority of investors we have talked to, the underperformance of value in Australia, following their global counterparts, seems to be a given. It’s just not true! In our view, simple, well-constructed value investment portfolios have outperformed the S&P/ASX 200 over the last decade.”
