Asian pension funds picking up on smart beta

Asia-Pacific pension funds are increasingly looking at how they can incorporate smart beta methodologies within their portfolio structure.

The concept is relatively new to Asia but is well established in the US and Europe. US and European pension funds and sovereigns from the Nordic bloc have been at the forefront of adopting more passive factor-based strategies to better match expected returns from equity and fixed income allocations.

In Asia, Japan’s Government Pension Investment Fund (GPIF) and Taiwan’s Bureau of Labor Funds (BLF) have both taken tentative steps in this direction.

Chris Woida, a director of BlackRock’s smart beta multi-asset group, based in San Francisco, is touring the region talking to the firm’s largest clients, including pension funds in China, Japan, Korea and Australia.

He says GPIF and BLF are good examples of institutions who could potentially make “massive allocations” to this approach.

In his travels around Asia promoting BlackRock’s multi-asset smart beta strategies, Woida says there has been a consistent theme. “In Australia and New Zealand they wanted to know about fixed income. In Hong Kong, fixed income. As the bull market in bonds appears to be coming to an end, investors are increasingly concerned about managing exposures to the common factors that drive returns for bond portfolios, interest rates and credit risk.”

In Australia, Woida found that “with all the fee pressure superannuation funds face under the new MySuper environment, smart beta is being looked at across the board to replace equity, fixed income and alternative assets.”

“Hedge funds don’t fit within their fee constraints, so the super funds are asking if they can get exposure to value, momentum, quality and minimum variance-type strategies through smart beta.”

He gives an example of one super fund who told him they had 15% of their portfolio in an absolute return basket, including some private real estate and private equity.  "They are looking to reallocate because their liquidity needs have changed and they want a portfolio ideally for less than 50bps."

Thomas Poullaouec, managing director and head of strategy and research at State Street Global Advisors in Hong Kong, commented: "In many cases, the asset owner has a well-diversified multi-manager portfolio, but when they analyse it, they realise they have a big passive portfolio paying active fees. That is one reason why funds are moving these portfolios more towards a formalised passive approach. It also gives them a greater element of control."

The approach may vary but the common factors are a desire to substitute active managers for passive and a growing need to reduce management fees.

In Europe, pension fund clients have found they can take a "quality bias" in building their government and corporate bond exposure using smart beta. This gave them the ability to avoid some of the risks attached to the eurozone. Woida has talked to one Chinese pension fund that wants to consolidate its active and passive managers, again with lower fees as a key objective. 

There are two typical client demands, said Woida: “Once the client knows what the outcome is, they say ‘can you deliver that return for a lower fee?' Or, 'I have allocated to 25 different hedge fund managers, but my liquidity needs have changed. If I give you 10% of that, can you invest it in something that has daily liquidity?'”

Even the large European pension funds are saying to Woida, “We don’t have the time to continuously monitor and meet the managers – we want to simplify and focus on the return need as the basis for finding suitable investment options.”

There is a perception that fees for smart beta strategies are high, and while this is true, it’s a marginal difference. Woida estimates there is a 25% premium from a passive market cap weighted approach. While fees to a pension fund for that type of strategy are typically in the range from 0-10bps, adding smart beta into the mix takes the range from 2-13bps.

"Smart beta strategies have done well because you are accessing liquid markets and the strategies are transparent,” said Woida, countering another perception that smart beta is an opaque methodology. Woida said the problem with smart beta is “a lot of [sell-side] people are jumping on it” and trying too hard to differentiate themselves.

“We are trying to bring it down to a few simple ideas that solve some basic problems for investors.” In that way they can help get these ideas across to the boards who will ultimately have to approve them.

Garry Hawker, Mercer's director of consulting in Singapore, acknowledged this problem: “Any large institution running their entire equity allocation actively will find that challenging. So it will seek out traditional market cap passive [strategies] and, in some cases smart beta, although how that goes is really a governance issue,” he suggests, referring to the challenge of getting the message across to a fund’s investment board.

BlackRock’s research into smart beta has led it to set up a group to assess the entire idea across asset classes. “Above all, we recognised we need to be able to articulate how people can use smart beta, removing the uncertainty and removing the career risk," Woida said.