As investors in Asia Pacific consider how best to maximise their returns amid continued market uncertainty, one investment trend gaining wider acceptance in the region is smart beta. This refers to using factors and index weightings other than market-capitalisation in order to obtain alpha.

For instance, Hong Kong’s $7.2 billion Hospital Authority Provident Fund Scheme last month issued its first smart-beta mandate. It has appointed BlackRock to manage a $200 million passive portfolio tracking the Russell 1000 Low Volatility Focused index. This was taken from its $600 million allocation tracking the Russell 1000 index, executive director Heman Wong told AsianInvestor

The pension fund had issued an RFP covering both active and passive mandates, and ultimately decided to go passive. For simplicity it retained BlackRock for the new strategy, noted Wong. It may consider expanding the low-vol strategy by transitioning the remaining $400 million from the Russell 1000 mandate, he added.

AsianInvestor understands it is now more common for asset owners to be discussing smart beta within their investment committees. They are also asking their external consultants how to integrate different factors, such as value, low volatility and earnings quality, into their portfolios.

Adeline Tan, head of investment advisory at Mercer in Hong Kong, said: “We have had more granular questions lately, now that clients are differentiating what smart beta really means. From our view, it means biasing portfolios towards certain factors, and companies that exhibit those factors.”

Some Asian institutions, such as Japan’s Government Pension Investment Fund and the Bureau of Labor Funds in Taiwan have been using smart-beta strategies for some time, as reported. Others, like HK Hospital Authority, are just starting down this road.

Roland Winn, New Zealand Superannuation Fund’s manager of investment analysis, told AsianInvestor that the asset owner was focusing on how its different strategies interact and fit together. For example, it would like to obtain a deeper understanding of the degree to which active investments load up on common factors such as China risk or the hunt for yield.

The investment team is also aiming to optimise NZ Super’s portfolio to account for disruptive themes such as technology, regulation and climate change impacts.

Taking all these things into account, the fund is considering adopting factor investing to systematically construct an alternative index according to pre-determined factors that it believes will deliver superior risk-adjusted returns over the long-term. It is particularly interested in low volatility and value.

Tan confirmed: “We see clients who have done their research and know the factors they want to focus on. That’s a bit of a departure, because smart beta is relatively new. But now the quality of the conversation is vastly improved.”

But while the willingness to embrace different factors is there, the problem of finding value within the individual factors is likely to be increasingly challenging.

Indeed, some asset owners are not convinced by the ‘smart beta’ approach. Mohamad Nasir Ab Latif, deputy chief executive of Malaysia’s $161 billion Employees Provident Fund said that while EPF’s investment team filtered its exposure based on certain factors, “it is not a ‘smart-beta’ thing; we don’t do that”. He told AsianInvestor he did not see this as an effective approach, because “the moment everyone invests in the same way, the arbitrage disappears”.

Tan confirmed that was the case now with one of the most popular factors: “Now of course, with this new burst of interest, low volatility is a crowded trade. It was a great idea that everybody piled into.”

There are concerns that investors have been chasing performance by investing more in expensive factors such as low volatility and that a sharp reversal of this trend is likely to hurt portfolios, although State Street Global Advisors suggests some aspects of this argument may be overstated.  

Another challenge is finding fund managers with the experience of managing according to these different factors. “You are not going to get many managers with five years’ track record on a pure factor-based strategy,” said Tan. “So there needs to be a more in-depth conversation with the managers capable of systematically analysing these factors.”

Players in this space include US fund giants BlackRock, State Street, Northern Trust and Vanguard, as well as quant specialists such as AQR, Guggenheim and Research Affiliates. Active managers such as Robeco and Dimensional screen the universe with quantitative factors at the initial stage, while UBS, Irish Life and Amundi offer index-tracking options.

Moreover, the market for smart-beta exchange-traded funds is likely to grow on the back of rising institutional demand, said Julie Kerr, Hong Kong-based director of Asia-Pacific financial services at consultancy EY.

“ETF promoters believe smart-beta products tailored to the needs of institutional investors put them in a sweet spot," she noted, "enabling them to capture funds that would otherwise have been divided between passive mutual funds and actively managed accounts.”