Future Fund reviewing approach to smart beta

Australia's Future Fund and Japan's Government Pension Investment Fund are delving deeper into the use of factor tilts and smart beta with the aim of replicating more cheaply the returns of their active equity managers.

With a new head of equities installed earlier this year, Australia's A$143 billion ($106 billion) sovereign wealth fund is reviewing its approach to this area.

Other Asian asset owners are also developing their smart-beta strategies, said Kevin Hardy, Singapore country head and head of beta strategies for Asia Pacific at Blackrock. He pointed to several recent mandates the US fund house had won, including one in Southeast Asia.

Raphael Arndt, the Future Fund's CIO, told AsianInvestor that the institution had several factor tilts in its equities portfolio. “We have both market cap passive and other strategies as well as non-market-cap-focused active strategies, such as value and quality. In fact, we’ve had quality as a factor tilt in our portfolio almost since inception [in 2007].”

A different approach

What's changed is that, in February this year, Björn Kvarnskog (pictured below) joined as head of equities from Swedish state pension AP4.

"Since he joined we’ve been undertaking a review of our approach to listed equities," said Arndt. “We are doing quite a bit of research right now into the benefit of different factor approaches and whether we should change our approach somewhat.”

The Future Fund and other large institutions in the region are taking advantage of the fact that there are better performance metrics and research tools available now for them to analyse their portfolios.

“There is now a greater ability to regress performance and see whether manager skill is adding value, rather than merely being an expensive way to access equity beta or other factor exposures,” said Arndt.

More detailed analysis of factors is becoming something of a trend among Asian pension funds, Hardy told AsianInvestor. “Asset owners are happy if they have strongly performing active managers. But in many cases, if you deconstruct the drivers of return, it isn’t actually as much due to manager skill as some investors would like.

“Where they find there’s sufficient skew towards a given factor and they can do that within a more cost-effective and reliable manner, then the option is to do so in an index-type mandate,” noted Hardy (pictured below right).

As another example of the trend, he said Blackrock had this year implemented a $300 million mandate for a large Southeast Asian institution.

“They’d done their research, but as with a lot of investors, they looked at [factors] as single pillars – so they’d look at momentum, they’d look at value, and realise there’s a degree of cyclicality to them.” He was referring to the fact that factors should be rotated over time to achieve the best performance. 

Healthy scepticism

Japan's $1.2 trillion GPIF has also done a lot of research in this area. “The bulk of GPIF's asset movement in the past two years has been in that space,” said Hardy. 

Yukiko Tajima, a member of the investment planning division at GPIF, confirmed it had adopted smart beta strategies for a portion of its equities portfolio. The fund is monitoring the development of smart-beta or factor-based exchange-traded funds, she told AsianInvestor. "We are vigilant that some ETFs, in particular actively managed ones, have higher costs and lower liquidity relative to cash equities or equity futures."

Other asset owners to have issued smart-beta or factor mandates include Taiwan's Bureau of Labour Funds, Hong Kong's Hospital Authority Provident Fund Scheme and New Zealand Superannuation Fund. 

Wealth managers, such as Singapore's HP Wealth Management, are also considering making moves into this year, although some, including Hong Kong-based EXS Capital, have advised taking care to do proper due diligence. 

Future Fund's Arndt also remains sceptical about some of the concepts around smart beta.

“A lot of these approaches are untested through all market periods," he noted. "Strategies that have outperformed as yields have compressed over recent years may perform differently if there is a regime change and bond yields increase.”

Arndt said investors needed to understand the factors and how they would behave in different market cycles, which is an area the Future Fund is focusing on.

Rotation required

Hardy agreed that it was difficult to sustain outperformance in factors such as value or quality through a range of different market cycles, so factors need to be rotated over time.

“Most investors have realised this,” he said. “The starting point for many of them has been a single factor. For the most part they have opted for minimum volatility.”

However, the attraction of minimum-volatility strategies has waned in the second half of this year, he said, which is causing investors to ask themselves what they should rotate into.

“We’ve seen a bit of a resumption in some of the value strategies and also some moves into combination strategies,” said Hardy.

Blackrock's large Southeast Asian institutional client went with a blend of factors – value, low volatility and high liquidity – for its smart-beta strategy. And another large Asian public pension fund client of Blackrock has put some $1 billion into a similar mix of factors over several mandates.