GPIF among funds adopting alternative index strategies

Many of the region’s largest institutional funds are increasingly relying less on major market indices and focusing instead on alternative index strategies as they aim to diversify portfolio risk and target alpha opportunities more accurately.

Among those leading the way is Japan’s huge Government Pension Investment Fund, which is about to embark on a second round of smart-beta investing mandates. This follows an earlier foray in 2014 when GPIF issued three mandates they labelled ‘active smart beta’.

The mandates are tied to specialised factor strategies. One used an S&P/Goldman Sachs methodology targeting value and low volatility. Another used Nomura’s RAFI fund for Japanese equities while the third employed a Dimensional Advisors strategy with the MSCI small-cap index as the benchmark for the Japanese market.

Other priorities

Smart-beta specialists in Japan expect GPIF to tender the new mandates before the end of this year. Paul Hoff, business development director for Japan at ERI Scientific Beta in Tokyo, told AsianInvestor that the giant pension fund had not expanded its smart beta programme since 2014 because of other priorities.

“For example, the chief investment officer, Hiromichi Mizuno, has had to focus on GPIF’s stated [environmental, social and governance] strategy,” Hoff said. The selection of the ESG benchmarks started in September last year and concluded in July.

“They’ve taken MSCI and FTSE as standard ESG benchmarks, with some customised elements. Those are what they are now issuing mandates on for passive investments," he said, adding that Nomura was among the companies chosen.

As we reported in June the $294 billion National Council for Social Security Fund in China has published a report arguing that index-based factor investing is likely to become a major trend among asset owners with lower risk appetites, such as pension funds.

They suggested that institutional investors with a low appetite for risk should prepare for a shift to passive investments and said factor-based strategies – which employ index weightings other than traditional market capitalisation – also have a good chance of performing well in China.

Hong Kong’s Hospital Authority Pension Fund made its first smart-beta allocation in July 2016, a $200 million large-cap, low-volatility mandate. The Hospital Authority decided to adopt a passive approach and migrated $200 million out of its Russell 1000 Large Cap portfolio to the new mandate, managed by BlackRock.

Hoff sees the trend taking off as index providers make more alternative products available, without threatening the dominance of established benchmarks.

A good example, he said, is the Nomura/Russell joint venture index, a new domestic benchmark to rival the Topix index, which the GPIF and others have put money into. "The reason is that if offered a better mix of assets than the Topix. But it didn’t take over; it is only maybe 10% of GPIF’s benchmarking."

Investors and fund managers will continue to use the major international indices, Hoff said. "The fund managers will say the larger indexes have a better futures market, which is a key reason why managers will support them."

"Confusing idea"

Some asset owners have found the idea of alternative indexing and smart beta too confusing, according to independent consultant Peter Ryan-Kane. “So they’ve gone all the way back to thinking about beta as being the market and making specific allocations to Asean equity or Asia hard currency debt, for example. They see these as components of their larger portfolio, rather than a broad index like MSCI World or Barclays Aggregate."

Thailand’s Government Pension Fund has gone to quite a specific benchmark orientation, said Ryan-Kane, as has the Timor Leste Petroleum Fund, "because I think they found the whole smart beta thing really difficult". Even some funds that claim to be doing smart beta – including some Taiwanese pension funds –  "are so constrained they are really doing index beta," he said.

Korea's Public Officials Benefit Association pension fund has evolved more of an absolute return strategy in the past two years, chief investment officer Dong-Hun Jang told AsianInvestor. Prior to December 2015, when he joined the fund, “Most of the strategies used by our external managers were quite similar and it was difficult to differentiate them. I realised there was quite a high level of concentration risk."

Since then he has started to diversify as much as possible. “But the focus of the portfolio was to outperform the Kospi index, while trying not to deviate too much from that benchmark," Jang said. "So we have a combination of small caps stocks and some dividend stocks, and I would say a 50% of the fund uses index funds and ETFs, to save cost."