Smart beta: Fad and fashion - Part 2

Despite the fact that smart and alternative beta strategies have been around for 50 years, experts have said advisers and fund managers were still unclear on the difference, Hope William-Smith finds.

Capital Fund Management (CFM) head of Asia-Pacific, Steve Shepherd said fund managers, advisers, and their investors faced several key issues which stemmed from a lack of understanding of “traditional” equity beta, as well as the many differences between the two strategies in terms of portfolio transparency and volatility, and fundamental usage differences, structures, processes, and outcomes.

“Smart beta strategies include the equity beta of the market, and are designed to give a better Sharpe ratio compared with the market as a whole. Alternative beta is trying to give you the extra return on its own, without the equity beta, by creating a diversified market-neutral portfolio,” he said.

“Advisers can have the impression that smart and alternative beta strategies are simply two ways of describing the same thing, which isn’t true.”

While smart beta strategies relied on long-only portfolio construction frameworks and rode the same market highs and lows as equities, Shepherd said alternative beta had little relationship with market indices which often proved beneficial in volatile periods.

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“Alternative beta strategies aspire to being truly market-neutral in construction, and aim to exhibit very little equity beta risk,” he said.

“What advisers need to understand is that if we have done our job properly, then our alternative beta strategies are truly de-correlated to the markets.

“If you are looking for something that is diversified, has little equity risk and absolute returns, then alternative beta is the better fit.”

Tempo Asset Management principal, Joe Bracken said the definition of alternative beta was the same as smart beta but applied almost always to hedge funds, which often led to confusion for advisers.

“There [are] new products that have come on the market and new terms have been coined to classify them,” he said.

“In recent years academics have identified certain common market inefficiencies (‘carry trade’, ‘trend following’) that are common to many hedge fund strategies.

“Alternative beta in hedge funds – much like smart beta in equity and bond investing – attempts to capture these inefficiencies and bundle them into a strategy that aims to generate ‘alternative’ returns for investors but at substantially lower cost than traditional hedge fund strategies.”

With regards to questions around portfolio transparency, Shepherd said smart beta strategies could be both transparent and simple as they were linked to the performance of underlying stocks, whereas alternative beta strategies were generally more complex.

“Alternative beta strategies can seem more opaque [and] understanding an alternative beta portfolio can be more difficult, because there is typically a much wider range of investment techniques, including a mix of long and short positions, as well as fixed income and other asset classes,” he said.

“However, the big benefit is that it is precisely these additional investment techniques and the huge amount of diversification that enables alternative beta to have no or low correlation with equity markets, which in turn reduces risk arising from traditional equity market beta.”  

To read the first part of this feature, click here