Taiwan's BLF lays out the lessons of smart beta investing
Similar to several Asia Pacific asset owners, Taiwan’s $175 billion Bureau of Labor Funds (BLF) has been an early adopter of smart beta strategies. Now 10 years on, it has shared some of its experiences with AsianInvestor.
Smart beta funds typically follow indices built using criteria other than simple market capitalisation. Instead, their methodology is based around factors such as book value, total sales or share price volatility.
The idea is to single out different market trends and combine them to reduce or increase an investor's exposure to specific risk factors.
Several Asia Pacific institutions have utilised investment strategies such as factor tilts and smart beta in recent years. The aim is to replicate more cheaply the returns of their active equity managers.
These include Australia's Future Fund, Japan's Government Pension Investment Fund and Hong Kong’s Hospital Authority Provident Fund Scheme.
Since 2011 the BLF, which oversees Taiwanese state funds including the Labor Pension Fund, Labor Retirement Fund and Labor Insurance Fund, has adopted a range of single-factor strategic global indices, including global fundamentals, low volatility, high dividends, high-quality and sovereign credit bonds.
Many of these factor-blended strategies are being used to replace active equity.
The BLF began this campaign with a $2.4 billion ESG smart-beta mandate and has since expanded this to cover a variety of market circumstances.
“The BLF’s strategic factor index strategies are used to give full play to the characteristics of each factor, so that the funds can maintain stable fund performance throughout the economic cycle,” a BLF spokesperson told AsianInvestor.
The various factor strategies currently account for about 35% of its NT$1.15 trillion in foreign mandates.
As a relatively new concept that has only been adopted widely in the past 10 years, smart beta has taken some time to evolve and mature.
Indeed, some asset owners are not at all convinced about the concept, or at least its adaptability. While the willingness to embrace different factors is there, the problem of finding value within the individual factors is likely to be challenging at points in the market cycle, say its critics.
ROTATION KEY
This point is well understood by the BLF. The spokesman said one of the chief lessons they have learnt from the experience is that it is 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.
"Only a truly diversified smart beta strategy can weather all markets," said the spokesperson.
However, tactical shifts are difficult to undertake sucessfully.
“With the increasingly fierce changes in the financial environment and the rapid rotation of stocks, it is not easy to quickly replace strategic factors suitable for the current environment. Only through a diversified layout of various factor index strategies can the overall investment portfolio volatility be reduced and a stable income achieved."
Although a single strategic factor has its own performance cycle, in order to further diversify the risk of a single factor, the bureau has combined multiple factors within static multi-factor index investments, including an Asia-Pacific mixed index and the global ESG mixed index.
In 2019, in order to keep the weights of strategic factors close to the changes in current market conditions, the BLF introduced a dynamic adjustment mechanism into strategic indices. It also added global emerging market dynamic multi-factor index investments, to allow for regular rebalancing among strategic factors in accordance with market conditions.
A spokesperson for the Future Fund confirmed that they too had evolved a diversified strategy to sustain periods of drawdown from individual factors: "Although relatively young in comparison to some of our peers, the program has performed in line with long-term expectations.
"Over shorter horizons, it has been a challenging environment for some factors, most notably value."
DEFENSIVE TRAITS
The Taiwanese team has analysed how the smart beta approach has performed in recent years, including during the exceptional circumstances of the global pandemic.
For example, in February 2020, when global stock markets fell sharply at the outbreak of Covid-19, the low volatility factor index strategy performed well.
“The decline has been significantly moderated, providing downgrade protection and support for the management of the fund," said the spokesperson.
Due to the Covid lockdown and strict epidemic prevention measures, home office work, study and web-based entertainment have become a feature of everyday life for many people.
“During this period, the kinetic energy factor and high-quality factor strategy with large-scale internet technology companies as important holdings benefited most,” added the spokesperson.
In November 2020, reports showed the effectiveness of local vaccine programs and market sentiment suddenly reversed.
“The previous value factor stock index strategy of energy, finance and raw materials, which had fallen sharply, then rebounded sharply and retraced the previous deep decline.”
As at the end of June 2021, the domestic equity and foreign investment portion of the overall portfolio had grown by 9.59% over the 12 months.
Looking ahead, the BLF told AsianInvestor the BLF investment council will continue to diversify the global programme to reduce the impact of market uncertainty. This could include an increase in the smart beta portion of the portfolio, it said.