Institutional interest is growing across Asia for smart beta investment strategies, which look set to spread from the deepest developed stock markets to local equity markets, bonds and alternatives too, market experts say.

Speaking with AsianInvestor in a webinar called "Finding the Way Through the Smart Beta Maze' on November 15 in association with FTSE Russell, senior executives from fund managers and advisers said the region’s asset owners have begun mixing multiple factors into their smart beta portfolios in order to attain more nuanced outcomes.

Smart beta funds typically follow indices built using criteria, or ‘factors’, other than a company's market capitalisation, which is what most standard equity benchmarks like the S&P 500 are based on. Instead, their methodology is based around different factors such as book value, total sales, or share price volatility, to name a few.

The idea is to single out different market trends and combine them in a multitude of ways to reduce or increase an investor's exposure to risk, based on what their objectives are.

The most developed smart beta solutions are focused on equities, in large part because stock markets are highly transparent and provide lots of data from which to create and measure factors. 

However, increasingly institutional investors are looking to employ smart beta strategies for fixed income and, especially, alternatives investing too.

“We are seeing some interest in the credit space but … it’s more muted [than in equities],” said Paul Colwell, chairman of the portfolio advisory group for Asia Pacific at Willis Towers Watson. “Where we see more is in the alternative beta space, which I’d characterise as a set of investment strategies that look similar to hedge funds.”

“I believe we will see much more interest in multi-asset [smart beta solutions] and credit in general,” Colwell added.

Christopher Vass, senior product manager for index provider FTSE Russell, agreed that fixed income strategies would likely gain more interest among asset owners in Asia.

But Vass added that smart beta equity strategies still have plenty of room to grow in Asia as here they are still "a bit underdeveloped”, drawing qualified support from Jonathan Shead, head of portfolio strategists in Asia Pacific for SSGA.

“Factor investing works best on large deep markets like the US or a global universe. When you get to a small local markets it can get quite tricky, because of the concentration risk of the dominance of particular sectors and so on,” Shead said. “I think we will see more development [in Asia-focused factor investing] over the next couple of years.”

Healthy Asia growth

Most investors in Asia have so far mainly used smart beta strategies to focus on large markets, particularly the US and Europe.

According to ETFGI, assets invested into smart beta equity exchange-traded funds or products globally rose by $134 billion in the first 10 months of 2017 to $662 billion. Of this, Asia Pacific accounted for only about 10%.

That said, many asset owners prefer tailored products to ETFs, so the regional total is likely much higher.

Colwell noted that asset owners in Asia were increasingly keen to use smart beta in equity markets. “Many of these factor-blended strategies are being used to replace active equity. Many of our clients have become disillusioned with active equity management,” Colwell said.

The low cost (typically 50 basis points or less a year in management fees) of smart beta investment and the fact it can be custom-built has appealed especially to some of the region’s largest investors. The Government Pension Investment Fund of Japan has used smart beta methods for years, as has Taiwan’s Bureau of Labor Funds, while Australia’s Future Fund is reviewing how it uses it.

“Asia represents 20% of BlackRock’s factors platform at this stage, whereas the region represents 10% of our overall business,” Ben Garland, senior investment strategist for the factor based investing unit of BlackRock in Asia, said, while noting that a few very large clients dominate the landscape.

Factoring in ESG

Another area getting a lot of investor interest is combining smart beta strategies with environment, social and governance (ESG) principles.

ESG is gaining traction in Asia as more major asset owners seek to utilise their large pots of money to push for greater corporate governance, asset stewardship and environmental considerations.

Garland said he believes there is a great deal of potential to wed the ideals of ESG with smart beta, and, potentially, even make ESG a form of factor itself.

There are just two problems: a lack of data, and returns. ESG depends heavily on getting a lot of data on company practices, which can be tricky.

“Good ESG data is so hard to come by that it’s hard to test your theories,” Garland said.

This has meant that some ESG strategies are more basic than asset owners would like and led some to view ESG overlays as a drag on the performance of their portfolios. But smart beta could change that by adding some throttle to ESG strategies, he added.

“People are coupling ESG with factor-based investing, because they are saying ‘ESG is net neutral or maybe even costly to my portfolio, so if I add factors maybe that can make up on some of the lost performance’,” Garland said.