CASE STUDY

Smart Beta

German industry pension fund | Summer 2017

Engagement at a glance

This German investor sought to invest EUR 100m starting volume with a target volume of EUR 250m in a multi-factor smart beta strategy.

CLIENT-SPECIFIC CONCERNS

The investor sought to move a significant portion of the passive equity portfolio to a global smart beta approach – the institution’s first foray in this strategy. Although they were open to all types of multi-factor smart beta strategies, they had relatively specific risk targets and structural requirements.

In particular, the investor wanted to limit drawdowns to 7% versus the benchmark and hoped for a target tracking error close to 5% (multi-factor Smart Beta products typically have a TE of 2-3%). The client also wanted a customised benchmark reflecting the asset allocation policy (excluding Japan and Emerging Markets) – a reasonably common requirement and, given the quantitative nature of the products, a straightforward one. Thirdly, a German Spezialfonds structure was necessary, as well as previous experience managing such structures and German-speaking client-servicing.


Outcome

  • The longlist (33) included a diverse group of managers, ranging from large international players to specialist quantitative firms and smaller boutiques. This represented a very broad universe given the investor’s specific structural and language requirements.

  • It is important to be thoughtful about tracking error parameters in this sector. Increasing tracking error in this space is usually directly linked to the proportion of low volatility rather than the alpha expected. The client ended up selecting a strategy with a lower TE target than they’d anticipated but generating very consistent relative return and information ratio.

  • Education and support were key for the investor’s first entry into multi-factor smart beta. This included detailed explanation of the various sub-strategies. bfinance provided deeper analysis of factor blending and how different managers deal with overlap / combination.

  • The client was keen to see proven track record, while wanting to keep a variety of strategies on the table (simpler and more complex, higher and lower TE, with and without low vol). However, they did not make multi-factor track record a requirement and ultimately chose to take one manager that had only recently launched a multi-factor strategy through to the due diligence phase.

  • Upon examination of bfinance’s analysis, they decided to lean towards simpler, more transparent strategies rather than more complex offers for their first ever mandate in this sector.

Our specialist says

  • The multi-factor smart beta universe comprises a core group of long-standing strategies and a smaller number of new entrants that bring innovations such as careful factor combination. Most managers fall into one of three clusters: long-standing lower tracking error strategies (‘enhanced passive’) providing broad factor exposures and limited tracking error; ‘new generation’ smart beta strategies launched post-crisis featuring a more protective flavour (low volatility factor); ‘active quantitative strategies’ with more ambitious return objectives, higher sophistication and less potential for customisation.

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