What is limiting scheme uptake of smart beta products?

Jonathan Reynolds: I would not say my portfolio of schemes is the most representative portfolio, but there is no smart beta in any of them, in the defined benefit element or the defined contribution element.

Robert Holford: Most of the DC market is still basically passive.

Reynolds: In DB the reality has been that assets have been inconsequential in their relative effect on deficit. Maybe that manifests itself in a relatively low uptake. But equally you have the issue of trustee understanding; before investing in things like smart beta, it is important that trustees know what they are doing and why.

Pensions Expert: What can the industry do to boost trustee understanding?

You have to have a belief that the medium to longer-term returns are there, and accept the fact that it is not going to perform at certain points in the short term and that is why you have diversification

Steve Artingstall, senior investment manager, RPMI Railpen

Scott Richardson: Educate. You have to make it accessible to the layperson. It is not hard to do, but I do not think many people are doing it in a very transparent manner.

Simon Hill: I would agree with that. It is about education and information, and the speed of proliferation probably does not help that. The problem for smart beta approaches is that for a lot of trustees, they remember active quantitative approaches that failed pretty horrendously during the financial crisis.

Richardson: That is where the need for education is clear: style investing works over time, it will not likely work every year. You are going to have bad years. So get people comfortable with that.

Hill: And I think there is also an issue for advisers like ourselves in terms of getting to a point where we are sufficiently comfortable with these products and they are sufficiently durable to take to a client.

I think multi-factor has got some traction because it is seen as answering one of the big charges against a simple factor approach, or single factor approach, which is that if it is not durable, what do you do when it goes wrong?

Richardson: That is a good point. Take, say, value as a theme – momentum is highly negatively correlated with that, and so then combining the two can be quite powerful. While the combination will not be guaranteed to work at all points in time they have worked well together over the long run. So, strategically getting exposure to a select few of these that are economically intuitive makes sense.

Steve Artingstall: The point about that is you are not actually necessarily trying to predict the return in the short term because you cannot, basically. So you have to have a belief that the medium to longer-term returns are there, and accept the fact that it is not going to perform at certain points in the short term and that is why you have diversification.

Holford: A lot of this debate happens at the top of the industry, where there is the sophistication to understand what is going on.

Richardson: You can walk anyone through a spreadsheet. It is no more than just ranking liquid securities within some universe of stocks, bonds etc along different dimensions and then you combine them together.

And you have to get that final column into a meaningful portfolio with a bunch of constraints: do not just buy all of the top-ranked securities, diversify it somewhat with a variety of factors. Most people understand that, but you have to be willing to sort of walk through why you have these different columns in that spreadsheet.

Holford: Education has to be tailored to the audience slightly as well – to be transparent it needs to be. Because a lot of people talk about education strategies in a broad sense, but you need to know who you are talking to, both culturally and on different levels.

Reynolds: Apart from the very large ones, most schemes are still heavily led by the consultants. And the consultants have not really, in my experience, been saying, ‘This is the way forward’. I think that is probably the reason the penetration is not great.

Hill: I think that is partly true, and we are still debating. We have split views on this between our colleagues, and I imagine it is the same in many other firms.

Artingstall: What are the main contrasting views?

Hill: Durability is one of the key things, and whether clients are able to take the sort of long-term view you were talking about. The effective time horizon for many trustees in the private sector is not as long as the fund if I can put it like that, and so periods of underperformance can be an issue with trustees.

Beyond that, there is a debate around which factor, what type of factors, might be appropriate in that debate. So I think it is a question of not having made our mind up as to that.

There are some products coming out with a style or a smart beta label for fixed income, but it is very nascent

Scott Richardson, AQR Capital Management

Pensions Expert: What is holding back growth of smart beta in fixed income?

Richardson: Data in fixed income is a pain. Just take a single corporate bond: the manner in which we trade is still over the counter, so just getting return data is an issue.

Then you have to worry about, ‘How do I map that data?’ These companies have complicated capital structures, so I have to make sure that the bond lines up to the right company in the right way. Then you want to do this for 20–30 years to build out a robust data set. Very few people actually have access to this.

Holford: Not to mention the amount of money it costs to do that kind of analysis, with no guarantee you are going to have a functioning product at the end of it.

Richardson: Of course. There are a few people starting to look at this, and there are some products coming out with, for example, a style or a smart beta label for fixed income, but it is very nascent.

Hill: I think the other thing we have mentioned quite a few times here is also, there is not a cost driver for it to happen in the fixed income space in the way it was in equities.

Artingstall: It is not really an area where you seek to make big outsized returns.

Richardson: For those employing LDI using government bonds I agree, but long-dated corporates for example are a natural sandbox to apply these ideas. A lot of pension plans are demanding long-dated assets, and you can just lay on top: you can use a long-dated index and take 1 per cent to 1.5 per cent tracking on top of that with a styles or a smart beta-type approach.