7IM’s senior investment manager Peter Sleep speaks to ETF Stream’s deputy editor Tom Eckett on picking the right multi-factor strategies, value making a comeback and the reasons why he has been reducing his smart beta exposure over the past 18 months.
Sleep joined 7IM in 2007 where he helps run the firm's AAP fund range which has $3.4bn assets under management. Prior to this, he was an analyst at MF Global and held a number of roles at Citi between 1990 and 2003.
Do you use smart beta or factor products within your clients’ portfolios?
Yes we do, but I think it is fair to say that we are using it a great deal less than we used to. I think many investors have found it very difficult to own some smart beta products over the last five years or so and we have largely reduced our smart beta allocation to a lower level.
How much of your portfolios does smart beta typically make up?
We only have about 5% in smart beta at present. If you had asked me that question 18 months ago, I would have said about 25% which was primarily invested in multi-factor equity products. However, we exited those products last year after a period of difficult performance. So far, the decision to exit has been a good one.
How do you view smart beta/factor-based ETFs?
It is another tool for an investor to select from. Investors come to investment intermediaries like us to get the return of the market.
With active managers or smart beta an investment intermediary might be able to achieve that return, with passive the investment intermediary is guaranteed to fall short of that return because of fees. Smart beta does offer some long-term prospect of achieving market returns after fees.
Which parts of the smart beta spectrum interest you most at the moment?
The present market regime is fascinating and the winning factors are momentum and quality. The market is rewarding long duration, “quality growth” stocks and ignoring value stocks.
All the momentum is in quality growth and quality growth investors are rampant. Investors who describe themselves as value are suffering and struggling to survive.
I do not want to try to predict when the present regime might end, but I think the value factor will eventually rally and is looking increasingly interesting.
When you focus on a particular smart beta product to invest in what factors do you take into account?
Jason Hsu, founder, chairman and CIO of Rayliant Global Advisors – who spoke at Beyond Beta Europe Digital 2020 – wrote a great paper called Finding Smart Beta in the Factor Zoo as a guide to help investors to think about all the different factors out there and to filter them down.
To paraphrase him, a factor needs to be broadly accepted in the academic world and it has survived peer review; it has worked out of sample; the factor works not just in the US, but works worldwide; the factor should be persistent and it can be explained by economic risk exposure or behavioural biases.
We always consider fund structure, tracking error and other things, but the factor has to be robust to start with.
Alongside smart beta and factor-based investing, we have also seen the rise of thematic ETFs – does this interest you?
Thematic ETFs are always interesting if only because they show what is going on in the market, I am not sure that I would ordinarily buy though.
Are you concerned by the recurring accusations of hacking and data mining levelled at all factors and smart beta strategies?
I think there is a lot of data mining going on and for this reason, I would add another rule to Jason Hsu’s list. Never consider a factor put forward by someone in a shiny suit from an American or French bank. The strategy will back-test beautifully but will be rubbish going forward.
The core smart beta strategies are well established and accepted. The premiums are robust but their returns are not linear and some have underperformed for a long period which can make them painful to hold.
How do you engage with clients about smart beta?
We have clients that are sophisticated and they are keen to understand what we are doing, but the majority of our clients tend to focus more on overall performance and economic outlook rather than the 'nitty-gritty' of what is in the portfolio.
When we do receive enquiries, I think it is possible to explain smart beta in simple terms and I find that most clients intuitively understand the concepts.
Are there any specific areas where you would like to see new products emerge?
We have been investing in factor-based fixed income funds from Robeco and TOBAM for some time and we have had a very good experience. It is more likely that we see ESG strategies and equity smart beta combined rather than more fixed income smart beta.
Smart beta is about alternative weighting to market cap and it may be relatively easy to incorporate the two if there is the demand. I am always happy to see innovation and competition in the ETF market. It is healthy and shows that capitalism is alive and kicking.
Does multi-factor investing interest you?
That depends. Some of the multi-factor strategies I have seen seem to be more geared towards generating trading volumes for the banks’ dark pools than making money for clients.
If I were to buy a multi-factor product, I would have a strong preference for investing with the large and research-led buy side firms like Winton, AHL, or AQR, who are incentivised to minimise churn, rather than an ETF issued by a bank or an ETF backed by a bank swap where churn can seem to be a goal.
By 2025, do you think you will be making extensive use of smart beta products and factor ETFs?
It could come a lot sooner than 2025. There is a good chance we will be looking for products that give us more cyclical exposure very soon as we recover from the coronavirus crisis. Smart beta could be the place to find that exposure in value ETFs or maybe sector ETFs.
This article first appeared in the Q3 2020 edition of Beyond Beta, the world’s only smart beta publication. To receive a full copy, click here.