The $37 billion Victorian Funds Management Corporation is looking to expand its fundamental indexing program, following the success of the portfolio in down markets.

VFMC has been running a $100 million “pilot” fundamental index portfolio since July last year. In that time it has returned around 4 per cent above its benchmark, the ASX300 (-19 per cent against -23 per cent).

“We’ve have had very positive results and it has certainly outperformed during rough times,” Laurence Irlicht, investment director, quantitative analysis, said.

VFMC is currently undertaking a “significant review” of its beta strategies, and executives are expected to decide within the month whether fundamental indexation will be implemented across a wider proportion of the fund’s equities. VFMC is also researching minimum variance portfolios, which together with fundamental indexing, is driving the fund’s push to create “better beta”.

Irlicht described better beta as an attempt to achieve more efficient market returns; avoiding the “noise from market sentiment that has exacerbated volatility over the past few months”. The fundamental index portfolio uses quant signals such as a company’s sales, book value, dividends, and earnings to select stocks, rather than weighting a portfolio based on market capitalisation.

A minimum variance portfolio would use quant techniques to select stocks based on company risk, and the correlations of those risks between companies. “Understanding risk is considerably easier than picking which company will outperform,” Irlicht said. “The theory says that you should be rewarded for taking on more risk, but tests we’ve done confirm [similar tests in] the US that have found minimum variance portfolios tend to deliver market or better returns, despite their lower risk. In the year to August, the MSCI Minimum Variance Index returned -5.5 per cent, out performing the MSCI World Index by 6 per cent. “Even in more normal times, the minimum variance index tends to outperform; is has beaten the [MSCI World] benchmark by an average 2 per cent over the past 10 years,” Adam Randall, associate director of quantitative analysis at VFMC, said.

“There appears to be unrewarded risk in the market and better beta is a way of exploiting market risk inefficiencies,” Irlicht said.