Asset owners increasingly embracing smart beta type products and strategies

14 July 2017   Category: News, Asia, Global, USA   By David Macfarlane

Axioma, a provider of enterprise market risk and portfolio analytics solutions, sees a strong overall demand for passive investments in Asia, in line with the recent global growth in the space.

Christopher Woida

In an exclusive interview with Asia Asset Management, New York-based Christopher Woida, managing director (MD) of index solutions at Axioma, talks about some of the passive products and strategies that institutional investors in Asia are embracing.

Asia Asset Management: How can institutional investors go about selecting the best exchange-traded fund (ETF) in every asset class?

Christopher Woida: For ETFs that are meant to track market-cap weighted asset classes (aka traditional passive); we recommend selecting ETFs based on the lowest total cost of ownership (management fees, fund expenses, bid/ask spread, taxes, tracking difference, premium/discounts, etc.). For ETFs that are "labelled" smart beta, factors, or other exotic systematic strategies, we never judge a book by its cover. We prefer to use a risk model to analyse an ETF's factor exposures to ensure that the portfolio is positioned appropriately. If using a risk model is not practical, we recommend studying an ETF's underlying index methodology to ensure it's targeting the desired factor exposure. Finally, we want to make sure that the ETF has realised low tracking error to its underlying index.

Would you say that ETFs are fundamentally changing institutional investing? If so, why?

Yes. In many cases, ETFs are liquid and cost-efficient market exposure instruments so they allow institutions to make timely tactical adjustments to their asset allocation, hedge away or tilt towards factors, or quickly raise or invest cash for short-term needs.

When it comes to ETF education in Asia, is the industry really doing enough?

No, we don’t think the industry is doing enough ETF education, period. This is a global concern. Marketing drives the ETF industry; it should be driven by quantitative research. In an ideal world, ETF education will focus on teaching investors about the risk factors that drive portfolio performance and creating an efficient and consistent methodology to identify these exposures.

ETFs have been setting new records for flows. But who or what is driving this growth, and how are these products being utilised?

  1. "Do it yourself" investors seeking low management fees, better liquidity, portfolio transparency, and tax efficiency.
  2. Investors that have thrown in the towel on active management.  
  3. Total Return investors that think smart beta and factor ETFs are a better value proposition than relying on traditional active managers.  
  4. Active investors that try to outperform the market based on market and/or factor timing.
  5. Investors looking for downside protection and lower realised volatility.

Can active and passive smart beta strategies co-exist? Under what circumstances should each strategy be used?

Yes. Although most investors can build a highly diversified portfolio using traditional passive and smart beta strategies, active strategies could make sense in some illiquid public markets and some private markets. For investors looking to access these markets, management fees should still be an important part of the due diligence process. For active managers that still believe in high conviction security selection (aka stock picking), we think it’s especially important to understand smart beta factor and common factor exposures. The best active managers will hedge away the undesired factor risk. In a similar fashion, investors that mix passive and active strategies together have a critical final step in their asset allocation: identify the total portfolio exposures and make any appropriate adjustments.

What are the most innovative ETFs you’ve seen in the past 12 months globally; what makes them stand out?

There have been a few consistent themes in the ETF market with very little innovation. Equity smart beta products continue to surface with the majority of the strategies targeting multiple factors. The proliferation of environmental, social and governance (ESG) ETF products is starting to resemble the smart beta bandwagon of the past few years. Finally, we are starting to see a few fixed income smart beta ETF products hit the market as well. In all of these cases, we have not seen anything groundbreaking… but I am hopeful there is plenty of room for innovation.