Asset Management

066 | Smart beta and factor investing

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  • David Gibbon, Head of Investment Strategy, BlackRock
  • Manuela Sperandeo, Head of Specialist Sales EMEA, iShares
  • Ben Seager-Scott, Director, Investment Strategy, Tilney Bestinvest

Learning outcomes:

  1. The origins and development of factor investing and smart beta
  2. The main factors, their risk and reward characteristics
  3. How to create a due-diligence process for recommending smart beta to clients
  4. The role of factor investing and smart beta in client portfolios.

You can find out more about smart beta on our dedicated 'iShares Smart Beta ETFs’ page. This includes videos, research, white papers and a copy of the ‘Smart Beta guide'.

Find out more about Tilney Advanced Passive Portfolios here


Asset Management
Learning outcomes: 1. The origins and development of factor investing and Smart Beta. 2. The main factors, their risk and reward characteristics. 3. How to create a due diligence process for recommending smart beta to clients. 4. The role of factor investing and smart beta in client portfolios. Tutors on the panel are: David Gibbon, Head of Investment Strategy, BlackRock Manuela Sperandeo, Head of Specialist Sales EMEA, iShares Ben Seager-Scott, Director, Investment Strategy, Tilney Bestinvest For professional clients only PRESENTER: Hello and welcome to Akademia. I’m Mark Colegate, and in this programme we’re looking at smart beta and factor investing. To find out more about what they are, and how you can potentially use them in client portfolios, I’m joined by a trio of experts. Let’s meet them. They are David Gibbon, Head of Investment Strategy in EMEA, part of the Factor Based Strategies Group at BlackRock; Manuela Sperandeo, iShares Head of Specialist Sales for EMEA; and Ben Seagar-Scott, Director of Investment Strategy at Tilney Bestinvest. David Gibbon, we’re talking about factor investing and smart beta; are they the same thing or is there a subtle difference between them? DAVID GIBBON: They’re related. I mean I think when we talk about factor investing it’s probably worth just starting with what’s a factor? Because I mean we think about factors as being persistent drivers of return that we observe broadly across asset classes. And the way that you can use factors speaks to factor investing varies. Smart data is one of those ways. It’s a way of effectively tilting an index exposure into a rewarded factor, like value, like quality. But it’s only one way that you can apply factors. Factor investing includes things like factor allocation, which can supplant asset allocation, thinking about how you allocate risk. It can go to manager selection as well. There are lots of ways that you can apply factors beyond smart date. PRESENTER: So in a sense factor is a long term proven source of return, how you then tap into that, smart beta might be a way of doing it but there are other ways of doing it. DAVID GIBBON: Indeed, I mean basically the research is both academic and it comes from investment practice. And we know that these factors work. The ways you can apply them are varied. PRESENTER: Well, Manuela, factor investing, is it new or has it been around for decades? MANUELA SPERANDEO: It has been around for decades definitely. The research behind it has been around the decades. We can find the first evidence back in the 1930s when value started to be research. What is new is really the technology: the access that we have to data that allows us to capture these factors in indices, for example, and then wrap them in products such as ETFs and give access to everyday investors to these factors. PRESENTER: And Ben Seagar-Scot, you’re buying funds; how much do you use this idea of factor investing when you’re putting models together? BEN SEAGAR-SCOTT: Well I think there’s really two ways to answer that. In one sense we’ve been using it for a long time, because a lot of active managers have already used a form of factor investing. So active managers that have a natural value bias, or a quality bias; in many ways that’s a factor that has already been embedded in a way in their investment process. So when you see active managers, often they’ll talk you through here’s my best process, I go through these steps. Then I have a shortlist and then pick stocks from those shortlists. So it’s something we’ve been conscious of for a long time. I think over the last couple of years there’s been a massive rise in ways we can access pure exposure, so do things like ETFs and normal tracker funds. So from a passive point of view we’ve been looking at them for the last couple of years, but it’s only really in the last 18 months that the products have been available to allow us to express these factors in a very pure way. PRESENTER: And how has that changed the way that you would put portfolios together? If say 10 years’ ago you wanted access to value you would buy an active value manager, what percentage now of a portfolio would be in giving you exposure to say an ETF that gave you exposure to value? BEN SEAGAR-SCOTT: I think that varies across the board, and it also varies with market conditions. We are still very much in the early days of the smart beta or alternative beta evolution revolution; however you want to view it. I think increasingly there’ll be more of the portfolios allocated in that direction as people become comfortable. Overwhelmingly though at the moment I would say the bulk of our client assets, and I think it’s probably reflected across my side of the industry, ETFs and passives tend to be in the more traditional well-known ETFs. And as people get more comfortable with those, as people get more comfortable with factors, then you’ll start to see more and more coming through, but it really depends on the market environment. PRESENTER: Well, David, we’ve talked about beta a couple of times, what’s a quick overview of what smart beta means and on the back of that is beta just the index returned or something a little different? DAVID GIBBON: Yes, so traditional beta is effectively funds that track the broad market. Typically indices are constructed in a market capitalisation way reflecting the entire investible universe. The bigger a company is the greater the weight within an equity index. The greater the debt outstanding the greater the weight of that issuer would be within a credit index. Smart beta moves away from pure market cap as a criterion for index inclusion and the weight in the index. And in particular you can construct indices that include criteria like the degree to which security represents value, or represent high quality, or represents high momentum. And these are all again rewarded factors that have persisted over time, and to the extent that you can build an index with smarter rules. You can create an index that will have better outcomes, better risk-adjusted returns in the long run. PRESENTER: And, Manuela, we’re hearing a lot about smart beta particularly over the last couple of years, but where’s the proof it’s here to stay rather than it’s a fad that we all love now but in 10 years we’ll look back on it and say goodness can’t believe we all did that in 2016? MANUELA SPERANDEO: Well let’s put it this way, if you look at the way the industry has grown it has been really phenomenal. So I think we estimate over the last three years in excess of 40% organic growth that you’ve had globally - only by looking at exchange traded products, trackings, more beta strategies. So there is evidence that this is really happening, that the adoption is getting broader and broader. From a persistence perspective, so as Dave alluded, we define factors as a broad persistent source return. And we believe that there are strong economic fundamentals behind this. And we believe that the drivers of this return are here to stay. So I think that it’s really a combination of the investment rationale behind these sources of return, and at the same time I think the adoption is also there to stay, and if something is actually increasing. PRESENTER: But we’re going through a period 2016, 2015, where markets have been volatile, and they’ve not really gone up at all. Does that, when that changes and we get to a point where traditional beta takes off again, at some point it will, do you think the attractions of smart beta will start to wane at that point? MANUELA SPERANDEO: I don’t think it will. And that’s because as more beta can cater to several outcomes. Of course it has the ability and the potential to reduce risk in the portfolio. But another main outcome that smart beta can deliver is actually excess returns in rising markets. Because some of these factors, they actually tend to outperform even in rising and more stable markets, for example momentum. When you have a market that is trending up, you do have momentum doing quite well. So I think if something, there are going to be environments where these strategies are going to be even more relevant. PRESENTER: In terms of pricing, Ben, I mean we hear constantly about the pressures on prices for product providers and advisers. Are these factor models and smart beta models considerably cheaper than active managers? BEN SEAGAR-SCOTT: They’re effectively halfway. So we’ve been through what some people would call a currency war in the traditional passive space. So S&P 500 trackers, FTSE All Share trackers, prices have plummeted. Go back a couple of years you’re paying a percent or more in certain products; now we’re down to single digit basis points. So they are a lot cheaper. I think these new smart beta ranges, they are between the ultra-cheap single basis points but still a long way lower than active management so sitting between the two. I would expect in the future, at the end of the day prices are set by competitive forces, and the price that the market will bear. I suspect as more of these launch, as in every other industry, not even just investment management, every other industry as you get more competition we might see more completion on pricing. PRESENTER: Manuela, very quickly, if we’re looking at factor based investing does it work best in an ETF wrapper, can you access it in a fund wrapper, what’s the preference? MANUELA SPERANDEO: So smart beta, again it’s beta so there is an index that aims to capture these rewarded factors. So once you have an index it can be wrapped into several vehicles. So one would be the ETFs. So if it’s important for you to have a vehicle that with intra-day liquidity and that trades on an exchange. But similarly you can wrap them into a traditional index fund, whereby intra-day liquidity is less relevant, but you still want to have a cheap way to track the index. PRESENTER: So it essentially comes down to how often you want your product to be priced. MANUELA SPERANDEO: Correct. PRESENTER: We’ve mentioned a couple of factors already; momentum and value. But how many are there that are generally recognised in the market? DAVID GIBBON: So there are some academic papers that suggest that the number is in the hundreds. We actually look at a much more limited set at BlackRock. And in particular we focus on two main sets of factors. The first are macro factors, and these are essentially risk premier that you earn by being exposed to adverse changes in the macroeconomy. It could be the risk premier that you earn by being exposed to a decline in growth or a rise in rates or inflation, or a pickup in default rates or political risk, a drawing up of liquidity. These are risk premier associated with the macroeconomy. And we think about asset classes as bundles of these risk premier. So the reason you earn a higher return on a risky asset is largely down to the fact that you earn a risk premium by being exposed to those macroeconomic variables. Those are macro factors. PRESENTER: Can you give us an example of one that’s floating around in the markets at the moment? DAVID GIBBON: Well I think the big focus right now is on growth, because clearly we’re in an environment where the market is starting to think about the possibility that we’re moving into a late cycle phase of growth in developed economies, and the implications for that for growth rolling over. I think the reward that you earn by being exposed to the growth factor is going to be critical. And it’s one of the reasons why equities have been as volatile as they have been. In many cases it’s repricing growth risk. So those are macro factors. The factors that you mentioned, value, quality, momentum, we call those style factors. And these are factors that are associated with characteristics of securities that history suggests are associated with outperformance of the broad market. So we know from our experience, as Manuela said, a lot of experience in terms of research, that high value securities, that is to say ones with attractive valuations relative to fundamentals, outperform the broad market over the long period of time. High quality, we’re emphasising robust stable earnings and sound balance sheets. Those companies tend to outperform over long periods of time. And that set of factors that we focus on span value, quality, momentum, carry, what am I forgetting Manuela? MANUELA SPERANDEO: Size. DAVID GIBBON: Size certainly. PRESENTER: This is the small cap effect essentially is it? DAVID GIBBON: Size is the small cap effect, exactly. So that side is quite broad. PRESENTER: Now you mentioned carry, what do you mean by that? DAVID GIBBON: Well essentially it’s recognising that higher income securities all things equal will tend to outperform. So what we’re looking for in high carry portfolios, whether it’s high dividend in equities or high yield within fixed income, is we’re looking for strong income per unit of risk. PRESENTER: Manuela, how do you go about identifying a factor that’s persistent? Because presumably there must be lots of things you look at and they look great for two or three years, and they just disappear and then never come back. MANUELA SPERANDEO: So I would say going back to my previous point around the economic rationale. So there is something that needs to be proven in terms of being very well researched in academia. And also there are other elements that we look for when we analyse all the different factors. One example is behavioural anomaly. So are there anomalies in the behaviour of individuals as investors that could drive these factors to persist. That brings us to believe that this is going to be in place. So for example low volatility stocks. Low volatility is a strategy where we’re seeing a lot of interest given current volatile markets. So the tendency of investors to overlook some low volatility stocks because they tend to look more at those with a growth characteristic. And this is sometimes referred to as the lottery ticket effect. So everybody, even though sometimes they do not admit, play the lottery. And that’s because everyone wants to make it big. So everyone tends to concentrate into stocks that have high growth characteristics, they’ve been going up really in price, and they tend to become very expensive. So when there is a correction these type of stocks tend to suffer, and they tend to fall in price very badly. And this is how this type of anomaly, we believe they’re still going to be there in place, and they’re going to support the return for example of low volatility stocks. PRESENTER: But when you pick one of these factors, when it falls from favour how long can it stay out of favour for when you look back at the records? MANUELA SPERANDEO: It could actually stay out of favour for some time, and this is actually one of the features that you need to get rewarded for. So also the so called cyclicality of factors is something that investors need to bear in mind. And for example value is a factor that has been out of favour for quite some time. It has been underperforming for a few years, and you get rewarded for that. So one of the characteristics that we look for is also the so called risk premier, and we believe that you do need to get rewarded for the risk of some of these factors not performing in certain environments. PRESENTER: Ben, picking that up, as a fund buyer how do you, it sounds like it’s not a one way ticket here. You could pick a factor and you could have two, three, four years potentially where, even longer where it doesn’t perform. BEN SEAGAR-SCOTT: And that’s why I think a lot of factors they have good long term risk adjusted performance. But as with any asset class they go in and out of favour, they have strengths and weaknesses. So when we look at putting together portfolios, we’ll apply our investment strategy. So we have a top-down view of the world, the sort of investment outlook we’re facing, whether it’s we think we’re going to go through a phase of strong growth in equities, or whether we think it’s perhaps more challenged. Environments where we might want to take a more defensive stance. And then we’ll pick those sort of factors and other beta products that matches our house view. So we very much view it as building blocks, and some of that performance may come by for example falling less hard but then rising less strongly in rising markets. So the number, your long term risk adjusted performance can hide different market environments which favour and disfavour different factors. So it’s a case of picking and choosing based on our house view. PRESENTER: I suppose the next question, Manuela, is how would you as a product finder go about implementing a factor? So I don’t know, let’s pick, we mentioned several but let’s pick one, say value, when you put a product together how do you create it so you think yes this has got perfect exposure to value, and it hasn’t got lots of other bits and bobs and white noise in there? MANUELA SPERANDEO: So when we build a product there are several considerations that we take into account. One, given that we are in the business of passive products, it has to be, these factors need to be investible. They need to have capacity, because of course we can be in an environment where these products gather a lot of assets, so we need to have underlyings that we can invest in large size and still be able to capture this factor. When we then build the product we want to look at what are the characteristics that we want to tilt for? So there are these indices, as Dave was saying, are built in a way to overweight stocks with value characteristics. So we want to understand what are for example the balance sheet metrics that we want to concentrate on? Because of course not all the products are going to concentrate on the same metric. So there is, you know, these products are passive but there is a lot of human judgement that goes into designing these. PRESENTER: But when you’re creating a product and you’ve identified say a stock as a value stock, is that value stock one that can appear in another basket like a momentum basket or a low volatility basket? How do you keep your stock exposure very pure? MANUELA SPERANDEO: Absolutely, that’s a very good question because there are stocks that can have exposure to more than one factor. So depending on whether our solution is a single factor product, or a multi-factor product. In a single factor, so we look for a characteristic relating to that specific factor. And what we try and do is also to measure the exposure to that factor vis-à-vis in the sector for example. So what we want to do is really capturing factors, capturing stocks that are good value within a certain sector. When we look at a multi-factor then the overlap becomes really critical, because we want to control for that. So what we do is for example in our multi-factor solution we want to maximise exposure to four of the factors that we think have the potential to give outperformance. And in that case what we try and do is controlling for the non-target factor. And the typical example again as you said is value and quality. So if we want to optimise our exposure to these two factors, the stock that bears exposure to both is definitely going to be overweight. PRESENTER: Well sticking with a single factor exposure, I mean how many stocks do you need in that portfolio to give you a decent coverage of it as a factor? MANUELA SPERANDEO: I think as a rule of thumb you can get some good factor bets by having approximately a quarter of the number of stocks from the parent index, which would be the market cap benchmark that we’re working on. PRESENTER: So if you were doing value from the FTSE 100, I’m using this as a very rough example, 25 stocks should give you, all other things being equal, the exposure you need to value in the FTSE 100. MANUELA SPERANDEO: Again bearing in mind that as we operate in our case our physical products, so we actually invest in the actual stocks, then we would have some capacity constraint as well as some diversification constraints, given that our products are UCITS. So in that instance we might want to start from a broader apparent, so it would be the FTSE All because maybe 25 would not be enough stocks to play with. PRESENTER: Picking up David, on this point, I mean with your role you’re looking at how you, as I understand it implement smart beta particularly across things like multi-asset products and where they can fit in the mix. Manuela mentioned correlation there, and again how closely linked are these star factors that we’ve been talking about? DAVID GIBBON: Yes, well I think the first point to make is that we see evidence of these styles working in lots of different asset classes. So I think we’ve focused a lot on evidence of styles in equities, but the reality is we see momentum working in fixed income, in FX and in commodities. Value is a feature of the currency markets. Carry works in lots of different sectors. There are volatility effects in multiple asset classes as well. And so I think there is, in the same way as Manuela says that it’s important to diversify your exposure to the bad times, the negative cyclicality of styles. There’s a diversification benefit by including style insights in other asset classes as well. And I think that’s one feature that we’re trying to build into a lot of our multi asset solutions focusing on factors for clients. You know, defining the universe of styles that we can include, that can generate returns for clients as broadly as possible to ensure that we have that intrinsic diversification. PRESENTER: So does a lot of this growth of factor investing smart beta come about really because of the growth of computing power? I mean is it that that’s allowed you to tease the truth out of the data? DAVID GIBBON: I think that’s part of it certainly. I think it’s the power of technology, it’s great accessibility to an expanding set of publicly available data. That is creating, I think it’s giving us more ability to apply these insights. It’s also I think empowering the industry, and I think to Ben’s point that creates competition. And I think ultimately that’s beneficial to investors. It’s spurring innovation, and I think it’s also impacting pricing. PRESENTER: I want to bring Ben in a sense, before I do quick question, is there anywhere today where you don’t think smart beta does work, or factor investing? You’ve talked about all these other asset classes where there are factors, but is there anywhere it just, it’s not worth going? DAVID GIBBON: Our broadest multi asset solutions look for style in every major liquid asset class. I mean I think the, possibly the next generation or the next frontier is maybe applying factors to illiquids, we see evidence that it works there as well, but I think what we’re focusing on right now is styles and liquid asset classes. And we see evidence that these style insights work broadly. PRESENTER: Well, Ben, given all this good news about factor investing and smart beta, what’s the role of active managers going to be in the future? BEN SEAGAR-SCOTT: I think active managers are still going to be here for quite a long time; hence what smart beta does do is it increases the number of tools in the toolbox. And as an investor at the end of the day I want as many different ways to express a view as I possibly can. Now admittedly some active managers might come under pressure, particularly there’s been a lot of concern in the recent past around benchmark hugger, closet trackers. I think as more factor indices come out and factor ETFs come out, perhaps some active managers will turn out to be actually just factor hugging. So those sort of active managers will come under pressure. But at the end of the day factors, I think, they’re designed to extract broad themes from relatively large asset class samples. I still think there’s going to be a role for active managers to do individual stock picking. At the moment there’s no smart beta type strategy that can look at a company’s balance sheet or can look at a company’s investment model, can look at its competitive advantages, shift in attitudes of consumers. I think that sort of additional level of qualitative analysis will persist, but obviously you need to pay a premium on top of that to cover all the research and that extra level of information. PRESENTER: I take that onboard, but some people might say well that’s fine, but is the cost of all that extra that you’re paying for an active manager, is it then produced in the level of outperformance they should provide above whatever their equivalent factor based index should be? BEN SEAGAR-SCOTT: Absolutely, and that’s a market and individual investor question. That’s why we have teams at Tilney Bestinvest that spend a lot of time looking at active managers. Our starting is that active managers don’t outperform an index unless we can prove to ourselves with qualitative and quantitative analysis that they do. But if they can then outperform over and above, and importantly after fees, it has to be an after fee adjustment, and that’s where I think active managers that can prove their mettle will have a role to play, and particularly maybe those more concentrated and high conviction managers that move further away from the benchmark. PRESENTER: And when you compare a manager to a benchmark in the future, will you compare them to a mainstream beta benchmark, say the FTSE 100, or would you say given the way they run money I need to compare them to a FTSE 100 benchmark with a bit of a low volatility and say a value bias built into it, and let’s see how they do against their factor benchmark? BEN SEAGAR-SCOTT: I would do both. I would measure them against their broad asset class. Because at the end of the day if they’re investing in shares in the FTSE 100 that’s their universe, so how are they doing versus a broad universe or their investible universe? I’d also compare them on a style basis. But also bear in mind one of the things you get with active fund managers, as well as the stock picking, they may well change, subtly change style over time. So in one regard as well you’re outsourcing some of these factor decisions and these style tilts to the active manager. So yes you can use factor ETFs and trackers to reduce the cost. The onus is then slightly more on you as an investor to make those decisions. PRESENTER: And, David, when you’re looking at BlackRock at multi asset products that are using factor investing in them, who decides on the allocation between factors; is that an active process or is that based on a series of, a rules based process? DAVID GIBBON: Well I think that allocation will vary from situation to situation. I think Manuela touched on one instance on how we can build indices that actually weight multiple factors and take into account the loading that individual stocks have on these rewarded factors across a set and build an index that way. We’ll also work with clients to understand perhaps what the factor biases are of a stable of active managers that a client likes. And then think about how specific factor allocations within say ETFs could be additive to that group to round out factor exposures. So there are lots of different ways that you can approach it. In our multi-asset products, we start with a blank sheet of paper and say what factor exposures do we want to have, almost the first thing to do is to emphasise diversification. We’re talking about a set of quite broad and uncorrelated sources of return, and almost the most important thing you can do is spread risk among them. There is a chance to be dynamic in terms of picking different styles at different periods of the cycles. That’s a very tough decision to make. And I think the very first thing to get right is to ensure that you’re diversifying that downside risk, and that’s what including multiple styles does. PRESENTER: Well let’s move on from, we’ve talked a lot about the theory and the main factors, but I guess the practicality of if you’re an adviser, how do you go about implementing this? How do you go about creating the due diligence process? First of all, Ben, when you started using smart bet and factor investing in your portfolios, what were you using it to replace? BEN SEAGAR-SCOTT: I think we were using it to, or particularly in the products we’ve most recently launched, we’re using it to get pure exposure to a particular element of our investment strategy. We set our investment strategy at a very high level, broad asset allocation, but actually the guidance we use goes down to quite a fine level. So what we’re really using these sort of products for, factor products, is as tools in the box, building blocks to try and really replicate our investment strategy. So our starting point is what are we trying to express? What styles do we prefer in a particular assert class. And then we carry out the due diligence, which aside from the actual instrument due diligence, which I guess is separate from our discussion today around structures. When it comes down to factors I think there’s three things that we look for. First of all as we’ve been talking about today, making sure that it’s based on economic or some sort of sound rationale and a fundamental basis with plenty of research that’s historical and being updated, and then I want to see is this being data mined? So we look at what’s called out of sample performance. So after they publish their paper does this carry on, does this persist after they’ve published, and that’s a good test. Just say they haven’t by luck said oh actually over this period it’s done this well, so it must go on in the future. And because a lot of these factors were established in the ‘90s there’s actually now a couple of decades’ worth of data, so we can really interrogate is this theme real and does it persist out of sample? And then finally the most important one is have I got a reason to think that this performance, this effectively anomaly, will persist into the future? And that’s particularly important. And that’s where it comes back to the investment strategy. Do I think what’s good for this factor, market conditions that benefit it, does that match with my current investment outlook? PRESENTER: Manuela, with your role you’re talking to a lot of advisers about how they could use ETFs, are they using them to replace active managers, passive traditional beta managers, and are they using these as core or satellite investments? MANUELA SPERANDEO: I think the great thing about smart beta is how flexible it is, and the multiple roles it can play in portfolios. So we’re definitely seeing advisers using them as a replacement. So for those underperforming managers that have not delivered what they’re supposed to, so they switch their clients’ exposure into passive tools which are at a fraction of cost. They’re more transparent, they’re more liquid. We also see advisers using ETFs to complement existing exposures, so for example picking some more defensive factor exposure such as quality in order to reduce risk in the portfolio. And then we can also see more sophisticated investors like Ben using them as building blocks. It’s around getting the exact exposure to one factor, and combining them in order to build a specific outcome. So it’s really multiple uses that these tools can have. PRESENTER: One thing I did notice, obviously this is a broad piece about smart beta in fact and not about BlackRock per se, but your product set at the moment doesn’t have any pure UK funds in it. I think you’ve got Pan European or global products. Given how many UK investors start by looking at the UK as their core exposure for equity and bonds, why that decision not to have pure UK product at the moment? MANUELA SPERANDEO: It’s really been, the growth of the range has been driven by demand. So I look after the distribution in EMEA, and so far we’ve seen the strongest demand coming for global exposure, so we have a well-developed equity exposure. We have some emerging market exposure. We have US and European equities. But you’re absolutely right, UK is something we’re being asked, and it’s something we’re currently researching. So again it was not deliberate, so we do think there are opportunities there. It’s just been driven by the demand that we’ve seen so far. PRESENTER: And, David, if I look at a number of these different factors and how they’ve performed, so momentum, value and so forth, over time momentum looks to win by a country mile. How much do, but obviously it’s quite volatile along the way. How much do people need to think about not just the returns they want to get, but the risk when they’re looking at these individual factors? DAVID GIBBON: Yes, I think the recent experience with momentum is a reminder that while this is a very highly rewarded factor, and as we mentioned earlier it’s observed broadly across asset classes, it is pretty volatile. It also requires some of the highest levels of turnover to maintain exposure to momentum. It can be, you know, risk-adjusted returns are strong, but the risk is high as well. And I think it’s again, there are lots of styles that are very complementary to momentum. So value is the classic combinator to momentum, and to the extent that you can create that combination you have a stronger portfolio. Momentum is highly rewarded but combinations of momentum and other styles are even better. PRESENTER: But if you put momentum together with value to cancel out the excesses of each, if I could put it like that, do you just end up back with the old fashioned benchmark, or do you end up with something a bit better than that? DAVID GIBBON: No, you can create diversified portfolios that have exposure to multiple factors that are differentiated from the index. And in fact that’s what we specialise in. PRESENTER: And how different can they be? Because I suppose the cynic from the outside would say well if you stripped one bit out I can see it would behave very differently from the index. But if you have lots of bits and put it back in you just end up with a bit of a compromise don’t you? DAVID GIBBON: Well the historical returns do suggest that these diversified indices that are exposed to multiple factors, just focusing on equities for minute, global equities, have ratios of added return to added risk that are north of 0.75 over long periods of time. So that’s to say that you’re, for every 1% of extra risk you have at least 75 basis points of extra return. That’s worth going after, and it’s pretty persistent in the long run. PRESENTER: Thank you for that. And moving one step back there, how do you create a due diligence process then around factor investing? Does it have to be different from what you’ve already got in place for active managers? BEN SEAGAR-SCOTT: I think there are elements that are common, and elements that you have to tailor specifically for factor investing. I think just as you would with any other manager you’d look at the process, exactly how stocks are selected. And importantly what sort of market are likely to favour and disfavour them. I think particularly when it comes to factor investing, because it’s rules based you can actually be a lot more robust in terms of your future consequences. So you can know what sort of environments will they do well and badly in, what are their strengths and weaknesses? And you can do various scenario testing, which is actually hard with an active manager, because if you ask an active manager they’ll say oh well it depends what’s happening in this scenario, what companies I like under that scenario. Because it’s rules based you can be a lot more rigorous. But like I was saying before, it’s most important to really make sure you understand the methodology behind it, and know why it will persist potentially in the future. PRESENTER: How do you get it passed compliance? And I don’t mean that in a negative way, but if it’s not a product they’re particularly familiar with, and you set, I mean we’ve got here, I mean this is a really good guide on smart beta from BlackRock here but you sort of said well, compliance said well we need to know a bit more about it, and you put a guide down that was 60 pages in front of them. I’m maybe judging everyone by my own low standards but my god that must be complex and high risk. BEN SEAGAR-SCOTT: Well in my experience most people in most compliance departments are onboard with advancing the business and taking it forward. They’re as keen as anyone else to embrace innovation. What they want to know is have we done thorough due diligence, do we understand these products? And that’s why so when we do it at Tilney Bestinvest both for compliance but also all of our other colleagues that are using these. You can have educational seminars, you can write fairly detailed reports that go from quite the high level elements we’re discussing here in a little bit of detail, right through to the nuts and bolts. And obviously you work closely with the various providers to really get under the skin, look at risk controls, look at the detailed methodology, all the way from the top level right into the fine detail, and then back out again. So as long as you’ve got a decent report and clearly explain what the product is, how it works. And most importantly show that you recognise both the strengths but also the risks and the weaknesses, and that’s what compliance I think are normally most concerned about. PRESENTER: Manuela, is there anywhere, a database perhaps that brings together all of these factor based products, smart beta products, ETFs, so that if you are an adviser and you want to find out more, and as importantly how you want to compare them with each other, you can do that easily? MANUELA SPERANDEO: So I wanted to build on something that Ben mentioned earlier on, the fact that now we actually have the toolbox. So in terms of the breadth of offering I think now it’s really there. We have a real track record, so some of these products have now been around for more than three years. For example the minimum volatility products now have in excess of three year life track records, so I think people can get more comfortable with that. And in terms of the actual index rules, I mean these are all publicly available data, so people can have a look at them and perform their own due diligence, especially around potential outcomes that these strategies could have in different market environments. So all our information in terms of our products is available in our standard beta, that’s where you can see the whole offering. And really the guide that you have is something that took a lot of time for us to put it together and really be as comprehensive as possible in terms of what you need to do to compare products. So in the guide we advise on a six-step due diligence process around defining the exposure that you’re after, what are the conditions that can be positive and negative for a product. And then of course index rules and cost considerations. But the beauty of having this strategy delivered via ETF is that we do have a lot of data now in terms of the broad industry. PRESENTER: But just picking up on that about the processes, but it’s pretty complex. What would you say to somebody who said my goodness, is all that extra work worth it? MANUELA SPERANDEO: I would say that it’s worth it. Because history is something that’s shown that you can get access to broad persistent sources of extra return vis-à-vis traditional indices at a fraction of the cost. So I think the work is worth, the effort is worth putting into. PRESENTER: David, we’ve got a couple of minutes left but David, one thing I did want to pick up with you is we’ve talked a lot about smart beta and different factors and how they work. Can you give us a couple of examples, perhaps worked examples from the past of how clients or perhaps you in your group have used smart beta to tweak exposures, to change things around, to I guess provide the outcomes for your investors that you wouldn’t be able to do without factor investing. DAVID GIBBON: Well we touched on one earlier. I mean it’s not a specific example but looking at a client’s collection of active managers, and assessing the aggregate style exposures of those managers. If you believe in this idea that you really want to have a diverse exposure to them, and you see a heavy concentration in value and size within an active management pool, then there is benefit of adding a little bit of smart momentum, smart quality through ETFs. And you can create a much more rounded exposure there, and I think that’s something we’ve been able to do with good effect. Manuela talked about the persistence of multi-factor returns in the long run, and I think the idea of taking static index allocations and improving the long-run outcome by producing better risk adjusted returns, by switching even just a portion into multi-factor product or into low volatility, these are the sort of portfolio enhancers that I think really will benefit clients in the long run, and those are the ones we’re working on with them. PRESENTER: Well final question for each of you, and I’ll start with Ben and I’ll finish with you David. If you had to leave people with one reason why they should be looking at smart beta and factor investing, what would that be? BEN SEAGAR-SCOTT: I think now with factor investing and smart beta you can really focus in and express in fine detail in a very pure way elements of your investment strategy in a way you couldn’t before. And for that reason alone I think smart beta is very interesting. PRESENTER: Manuela? MANUELA SPERANDEO: For me it’s around the ability to empower your investor, and ultimately your clients, to get access to these time tested sources of return at a fraction of cost. PRESENTER: David? DAVID GIBBON: For me it’s diversification and cost efficiency. Include more styles, you have a more diverse set of drivers of returns. That’s good in the long run. And it’s about making sure that you’re paying the right price for the returns that you’re generating. There’s still a really important role for active management, but I think we talked about it earlier, understanding how smart beta and active management can be complementary should lead to better cost efficiencies in a diverse portfolio. PRESENTER: We are out of time. We have to leave it there. Thank you all very much. And thank you for watching. Do stay with us. Firstly that guide to smart beta that I was mentioning is available on the BlackRock website. And if you do want to find out any more about this as a topic do please have a look for it. There’s lots and lots of good information and tables and charts in that. And secondly do stay with us because we’ve got our learning outcomes coming up next, so that’s how you can use this as part of your structured CPD. From all of here goodbye for now. In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. 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