Asia instos tempted by multi-factor and ESG cocktails
Investors across Asia are becoming increasingly interested in diverse smart beta strategies, with institutional investors inquiring more about combining multiple factors and some mixing them with socially responsible investing strategies.
Smart beta refers to investment strategies that use attributes other than market capitalisation to target better returns via a passively created portfolio. The most common factors used to pick the portfolio assets are momentum, low-volatility, value, dividend, quality, size and risk.
Regional interest in factor investing has existed for several years among Australia's superannuation funds, while the Government Pension Investment Fund of Japan has built a $17 billion smart beta mandate since 2012. Several others have invested into factor strategies too. Taiwan’s Bureau of Labor Funds (BLF) is one of the most assertive; it has six smart beta mandates and is considering issuing new ones.
Other institutional investors are looking add more smart beta allocations too, to diversify their portfolio risk and to shift assets away from expensive long-only active fund managers or even pricier hedge fund investments. And they are increasingly looking to multi-factor strategies as part of these diversification efforts.
Globally, 64% of asset owners have a multi-factor asset allocation, FTSE Russell noted in its 2017 smart beta survey. And multi-factor requests are among the most popular ones that FTSE Russell now receives in Asia.
“The question is how to combine them,” Christopher Vass, Hong Kong-based senior product manager for FTSE Russell, told AsianInvestor. “We advise that the investor have clear and specific objectives. They need to consider the level of risk [they want to target], whether they are replacing a highly active fund with a tracking error then they can consider more concentrated or high conviction factors, versus something very diversified.”
"Every asset owner has different objectives and constraints so standalone solutions increasingly don’t suit current needs,” added Tianyin Cheng, director, strategy and ESG indices of S&P Dow Jones Indices, told AsianInvestor. “I’d say most investors [investing into multi-factor strategies] are doing strategic rather than tactical asset allocations.”
She added this means these investors are looking for low correlations between the factors they choose to gain diversification benefits.
Popular combinatios
Currently the most traditional factor combinations of value and growth remain the most popular, mostly due to legacy reasons. Cheng added that growth and dividend factors are also quite popular, because these factors are typically simpler to understand.
“If you go beyond those there are combinations of low volatility and quality and multi-factors competing for a fourth position,” she said. Quality, value and momentum combinations are also gaining interest, with S&P Dow Jones offering a low volatility and low drawdown structure with these three factors, but Cheng said investors are interested in a huge variety of combinations.
S&P Dow Jones Indices and FTSE Russell did not immediately respond to questions about the number of smart beta strategies being used by Asian investors, or the volume of assets that are following them. However Priscilla Luk, managing director for global research and design at S&P Dow Jones Indices, said in a blog datad November 6 that factor-based exchange-traded products only account for 4.3% of regional ETP assets. That leaves a lot of growth potential.
Factoring in ESG
Another way institutional investors in the region are weighing an alternative approach to asset allocatio is to incorporate factor strategies with environmental, social and governance investing approaches.
Cheng noted that some investors have sought to add an ESG approach on top of a smart beta allocation to ensure risk control, either for regulatory of reputational purposes.
Others reverse this approach, and have an ESG asset allocation that they then run through a factor overlay to form a portfolio of assets. She said this was designed to offer some return to the portfolio.
“ESG as a factor itself is very difficult to provide outperformance. So investors are seeking to combine factors with an ESG allocation.”
It’s a point that FTSE Russell’s Vass agreed with. “We have seen a lot of uptake, especially in Europe, in terms of combining ESG [strategies] with smart beta risk premiums; we call it smart sustainability,” he said. “A lot of investors have noticed that with ESG you might run the risk of giving up some returns and one way to mitigate that is to put in factors or risk premia.”
He noted that Australian superannuation funds have been seeking to combine ESG and factors into investing strategies, while Taiwan’s BLF has also explored possibilities in this area.
Cheng said another example of this combination approach in Asia was Singapore’s sovereign wealth fund GIC, which invested several million dollars into the S&P Long Term Value Creation Index, which was created in 2016 by the Canadian Pension Plan Investment Board to target sustainability and financial quality to generate better returns. In total, six institutional investors invested $2 billion into funds following the index at the outset.
Bank of Japan offered another example of mixing smart beta and ESG in May 2016, when it was conducting its investment plans into exchange-traded funds. Cheng noted the central bank helped establish the JPX/S&P Capex and Human Capital Index, which targeted Japanese companies that invest into capital expenditure and human capital (therefore involving a ‘social’ context), but was also low volatility. That combination made the index more attractive for investors, she said.
AsianInvestor will be conducting the ‘Finding The Way Through The Smart Beta Maze’ webinar on November 15th at 4pm Hong Kong/Singapore time, exploring the latest developments in factor investing among the region’s institutional investors. To register for free for this webinar, please click here.