Twenty years of data on behavioural trading anomalies is enough evidence to show that factor or smart beta strategies have a high probability of working, Northern Trust’s head of global equities told delegates at the Fiduciary Investors Symposium.
Matt Peron, who looks after active, passive and smart beta portfolios for Northern Trust, was answering what he described as the number one question on smart beta from clients, namely “can these factors persist?”.
Peron’s remarks came in a presentation which told of how his smart beta team choose stocks based on the factors of low volatility, high dividend, high quality, momentum, size and value to help engineer portfolios designed to complement investors existing mix of risks, liabilities and assets.
“Having done this for 30 years it is clear that there are behavioural anomalies in markets,” said Peron. “We do not see the structure of the market has changed that significantly. We believe these factors will persist.”
He explained that the low volatility premium exists because of active managers buying high volatility stocks and the premium for value stocks exists over five years, due to a lack of patience by investors to hold such stocks.
He added his team had looked at other equity premium factors, but found them to be transitory or harder to prove. “If there is not a behavioural or structural reason we will not put them into our platform,” he said, adding that he knew of around 15 academic papers backing the factors his team relied on, giving them confidence they will persist.
Peron listed several ways in which his clients were using such factors in equity portfolios.
He showed how a US defined benefit fund was planning to cut its fixed income allocation from 40 per cent to 20 per cent. The gap is to be filled with a low volatility equity portfolio tailored to approximate the fund’s liabilities and to pay a higher return to build the fund’s surplus.
He also told of how multi-manager portfolios could introduce inefficient ways of capturing the factors listed above, and so engineered portfolios that redress such imbalances were another popular offer to clients.
Lastly, he showed the optimal mix of factors to help build a portfolio with a fixed time horizon, revealing that a 40 year portfolio should ideally have very little low-volatility exposure, but that this was the opposite for a four year portfolio.
Peron’s presentation was matched with case studies from QSuper and Perpetual Private on the use of smart beta.
Both Alex Waschka, senior portfolio manager and economist at QSuper and Kyle Lidbury, head of investment research at Perpetual Private, revealed how they were using smart beta portfolios to skew away from the market cap exposure they had with other fund managers. In the case of Lidbury, this was done to help achieve what he described as a “sleep easy, growth” strategy for private clients that focused on quality and high dividend stocks. It was also done to skew global equity portfolios away from sectors already highly covered in Australian equity portfolios.
Waschka revealed how QSuper creates its own smart beta indices to dampen the volatility of its market cap exposure with other managers. QSuper had undertaken this work itself due to the strength of its in-house quant team.