A fundamental approach to smart beta

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DIAM caters to rising demand for new types of market weightings

By Toby Garrod

Smart beta is displaying clear potential to become a mainstream product as major institutional funds globally increasingly show interest in the theme. As providers move to serve the demand, DIAM, the global asset manager headquartered in Tokyo, is carving itself out a niche at the active end of the spectrum, incorporating a greater focus on the active side than most of its competitors in this passive-leaning field.

Popularised with characteristics-based or fundamental indices from 2005, smart beta has experienced remarkable growth in recent years. While total inflows into advanced beta funds over the past three years have hit US$81.6 billion, according to EDHEC-Risk Institute, the data on funds does not take into account most of the investment in smart beta, which is done through institutional passive investment mandates. The institute estimates that the smart beta market is currently worth more than $500 billion. In time, smart beta should represent almost 30% of institutional investment in equities, it says.

“While the West is further along the curve than Asia is, we believe things are close to a tipping point in terms of catch up,” says Chris Williams, director of quantitative equity investment at DIAM International Ltd. “Taiwan’s $52 billion Labor Pension Fund became the first large institutional investor. As a result, other major Asian pension funds are likely to start following their lead. It feels like we’re quite close to the point where it’s really going to take off.”

Smart beta has traditionally been dominated by fundamental and minimum volatility approaches. It has normally been considered as any weighting system that represents an alternative to cap weighting – it would normally be defined by a simple set of rules, or a simple methodology. But today things are different. Investors are increasingly looking to diversify their smart beta investments, because diversification allows them to obtain more robust outperformance compared to cap-weighted indices and avoids them being solely exposed to small cap, value, low beta or low volatility biases. One way of achieving such diversification is through the inclusion of active factors, which broaden the range of smart beta options.

“At DIAM we have sought to improve upon a naive smart beta approach by incorporating our investment models so that we can also identify whether a stock has attractive fundamentals,” notes Mr. Williams.

DIAM has three smart beta strategies running at the moment, which span the global equity markets. The first based on the All Country World Universe, is a global equity high-income strategy that utilises a minimum variance approach. It also has an emerging market small cap strategy, also based on the minimum variance approach. Meanwhile, from Tokyo it runs a Japanese equity high-income minimum variance strategy.

“DIAM distinguishes itself from other providers by going beyond plain vanilla smart beta,” says Mr. Williams. “We incorporate our excess return model, which we have been using for 20 years to add value to cap-weighted benchmarks, into the smart beta world. It’s equally applicable to this area, so our approach has been to add it to our smart beta offering to incorporate alpha.”

In terms of balancing an institutional portfolio with smart beta, Mr. Williams suggests replacing assets at the passive end of the spectrum rather than the active.

“Obviously an investor might want to take a broad review of the entire portfolio,” he says. “But generally, we would look at smart beta as more of a substitute for passive. Nevertheless, as our products have an alpha component, we can hopefully offer investors something that covers the passive end, while also giving them alpha as well.”

Such offerings aren’t magic bullets for investors of every stripe, however. Smart beta products are likely to have quite a high tracking error against the cap-weighted benchmark, and at times may underperform by a large amount and for an extended period, which means that investors closely tied to such benchmarks over short timeframes would find these products unsuitable. 

But, if investors are able to have a more long-term view, and importantly, consider performance on an absolute risk-return basis rather than remaining tied to a benchmark, then it’s a very attractive approach.

“The majority of both institutional and retail investors would be appropriate end users of these products,” notes Mr. Williams.

For more information, please contact:
DIAM Co., Ltd.
New Tokyo Bldg., 5F
3-1 Marunouchi 3-chome
Chiyoda-ku, Tokyo 100-0005, Japan
Tel: +81 3 3287 1715
Email: english-info@diam.co.jp
Website: http://www.diam.co.jp/english/


DIAM ASSET MANAGEMENT is the global brand name of DIAM Co., Ltd. (Tokyo) and its subsidiaries worldwide. The offices mentioned above are authorized and regulated as required within their respective jurisdictions as follows: DIAM Co., Ltd., by Financial Services Agency of the Japanese Government, DIAM International Ltd, by the Financial Conduct Authority, DIAM U.S.A. Inc., by the U.S. Securities and Exchange Commission, DIAM Asset Management (HK) Limited, by Securities and Futures Commission of Hong Kong, and DIAM SINGAPORE PTE. LTD., by Monetary Authority of Singapore.

This document is strictly for information purposes only and is directed to professional investors and eligible counter parties as defined by relevant authorities where DIAM’s offices are located. This document does not constitute any offer or solicitation of products or of services in any jurisdiction or in any circumstance that is otherwise unlawful or not authorized.