All strategies work – until they don’t. While the hottest ticket in town is still private credit, is it everything it’s cracked up to be?
In Cliff Asness’ latest missive, a fictional asset allocator from the future looks back on the decade to 2035 to figure out which assets helped their performance and which hurt it.
Smart beta decisions not as simple as you may think
(Pictured: Bob Browne)
Smart beta strategies are not without their risks, nor their costs. They are becoming increasingly popular, however, as super funds tweak their portfolios ahead of what many see as an end to the recovery period for major share markets post global financial crisis.
Immediately post crisis, institutional investors became more interested in traditional passive and low-volatility strategies. Overseas, but probably less so in Australia, they also tended to lift their allocations to alternatives.
Now, aided by vigorous marketing from quantitative managers, investors are looking for something extra from their passive portfolios – a little more return and/or a little less risk.
Bob Browne, the CIO for Northern Trust Asset Management, presented to the Australian Superannuation and Investment Conference this month on the wisdom of combining multi-factor (smart) beta strategies, rather than single-factor strategies.
If drawdown periods represent the main investor concern, the best-performing factor for returns over the period from 1979 to 2012, for instance, was low volatility. This had 25 years of positive returns and nine years of negative returns. Dividend yield strategies had 22 years of positive returns over the same period, value 20 years and size 18 years.
However, in the most recent four-year period, low-volatility strategies produced annualized returns of minus 19.5 per cent. In the same four years, dividend yield returned plus 15.9 per cent, value plus 13.4 per cent and size plus 3.6 per cent.
“Single-factor tilts can be subject to extended periods of poor performance,” Browne said. He said it was important to not only identify the factors which can enhance an index but also to combine them in an efficient fashion. “You shouldn’t take uncompensated-for risk,” he said.
Paul Bouchey, managing director of research at Parametric Portfolio Associates, pointed out that smart beta strategies were “not naturally tax efficient”. He said smart beta managers typically ignored the effect of taxes on their portfolios.
“There is increased drag due to the higher turnover {of smart beta] compared with pure passive,” he said. This was the case, according to Parametric research, for each of the popular smart beta strategies: equal weight, fundamental weight and minimum variance.
