How Devon is approaching its alt equity smart beta strategy
Devon Pension Fund has set out its approach to its mixed alternative equity index, using the smart beta strategy as a middle way between active management and the fund’s large passive allocation.
Smart beta strategies are a lower-cost, rules-based form of active management that seek better risk-adjusted returns than a market capitalisation-based index, and are seen as a halfway house between active and passive management.
European investment in such strategies reached €72.7bn (£54.9bn) in 2014, up from €52.3bn the previous year, according to recent analysis by research company Morningstar and manager State Street Global Advisors.
Devon’s investment manager Mark Gayler said: “It’s about trying to get a better return than the market cap index… doing something that will provide an enhancement of a passive approach at lower cost than active management; it’s treading a middle course.”
Devon put a mandate out to tender in October for management of £250m, or
8 per cent of the fund. It is to be run across a mix of value, quality and low-volatility strategies, while avoiding single-factor dependency.
Philip Tindall, senior investment consultant at Tower Watson, said he thought diversifying across a range of factors would deliver a set of uncorrelated risk premia.
But he added: “Arguably there’s less transparency and there are decisions about how you put these ideas together. There are overall quantitative benefits in diversity terms to doing it but it requires a more sophisticated approach.
“It isn’t about blending approaches and jumping on the bandwagon – it’s not a free lunch.”
The consultancy’s clients have begun to combine momentum with other factors, allowing them to maximise opportunities in the short term by buying securities that have gone up in price over the past three to 12 months, Tindall reported.
“It’s not straightforward, practically there’s a much higher turnover because it’s much more actively traded,” said Tindall. “There would be increased transaction charges.”
Peter Martin, head of manager research at JLT Employee Benefits, said investors should always be open to new ideas but think carefully about how they are capturing forms of risk premia in a consistent and reliable fashion.
“Sometimes there’s a wider, long-term argument about the premium you want to obtain,” said Martin.
Consultants were in agreement that a blend of factors could offer good diversification in the long term, but that such approaches were driven more by risk than returns.
Providing defined benefit pension funds with low-cost alternatives to actively managed hedge funds or diversified growth funds, dynamically diversified beta strategies could provide low-cost investment vehicles for defined contribution investing when delivered within a target date fund.
Henry Cobbe, head of research and managing director at Elston Consulting, said: “Smart beta is interesting when it focuses on asset allocation. Dynamic diversified beta inside a DC strategy… has to be delivered with time horizons because there are rules on defaults.
“It’s about risk-based investment but there’s scope for DC strategies to incorporate smart beta elements so long as they deliver an asset allocation. This is seen through the recent launch of a dynamic diversified beta fund."