16/04/13

Alternative beta has a wide umbrella - FT.com

March 22, 2013 6:25 pm

Alternative beta has a wide umbrella

By Inigo Fraser Jenkins

A paradigm shift is taking place in fund management. For years we have all been schooled in the idea that fund management could either be passive and track an index, or be active and try to beat that index. There is now, however, a greater willingness to steer a middle path that is often described as alternative beta. The pages of FTfm have, for example, carried several articles in recent weeks referring to the switch into alternative beta that some investors are making. What is meant by this? The term is used in a confusing number of ways, but Nomura suggests there are two core meanings. First, it can refer to a strategy that was once thought of as being active, but has now been commoditised or packaged in some way, such as an exchange traded fund. Examples of such strategies would be value investing or minimum variance. Second, it can refer to a non-traditional benchmark, one that generally outperforms the market-cap weighted benchmark, or is better aligned to an investors liabilities in some way. Why is this happening now? There are several reasons for this switch. First, the sharp fall in the share of active management relative to passive is leading asset managers to pursue other opportunities. There is also widespread and growing dissatisfaction among investors with benchmark-relative concepts of return and risk, which are perceived to have failed in recent years. We would also note that with products such as ETFs it is now much easier to take on macro-type exposures. In a recent research report, we brought together three current areas of debate in finance that are seen as separate, but are set to increasingly converge as one subject area. These are the increased appetite for multi -asset investing; the rise of alternative beta itself through greater investment in alternative beta ETFs; and the challenge posed by the decrease in active assets under management and what fund management companies can do in response. Another type of strategy that has become increasingly popular in recent years is highly active, concentrated stock-specific funds with, say, fewer than 30 stocks. This is the antithesis of alternative beta. Such funds have gained market share over the past two years, and offer high margins for those who are successful. These funds are likely to continue in popularity, but will be part of an increasingly shrinking share of active stock-selection-based assets.

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16/04/13

Alternative beta has a wide umbrella - FT.com

What is the business opportunity for asset managers here? One option is to offer the underlying strategies that form the vehicles for alternative beta approaches. However, this will be low-margin business and may not appeal to all. There are two other options: one is to offer highly customised solutions to individual clients, combining these strategies in a way that is optimal for their liabilities. Another option that is increasingly talked about is dynamically switching between such strategies. So, for example, rather than allocating tactically between an equity and a bond index, a multi-asset manager may instead decide to allocate between the carry in rates and value in equities. There is a spectrum of approaches that can be considered alternative beta. Some will be familiar to many investors, including style returns such as value, quality and momentum. Other strategies will be some of the alternative index approaches that have become popular over the past two years. These would include minimum variance strategies that try to achieve the lowest possible volatility, maximum diversification and so-called fundamental indices that weight stocks by accounting measures rather than market cap. All these can be subsumed within the alternative beta trend. Recent academic work has compared the returns of such approaches. Our research has placed valuations on these strategies, linking them to the business cycle and is a step towards a tactical timing model. This is a relatively new area, and the economics of how participants can best profit from it are open to debate, offering potentially interesting opportunities.

Inigo Fraser Jenkins is global head of quantitative strategies at Nomura

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Alternative beta has a wide umbrella - FT.com

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