Lyxor highlights growing role of smart beta in investment strategies

Sep 17th, 2016 | By | Category: Equities

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European exchange-traded fund provider Lyxor Asset Management has unveiled the results of a wide-ranging study comparing the performance of European-domiciled active funds with that of their benchmarks. The research highlights the growing importance of risk factors and other smart beta strategies in generating performance in the current challenging market conditions.

Lyxor highlights growing role of smart beta in new investment strategies

Lyxor has identified five factors that drive portfolio performance.

The report compared 3,740 active funds, representing €1.2tn in assets under management, to their traditional benchmarks over a period of ten years. It found that 47% of European-domiciled active funds outperformed their benchmarks during 2015, significantly more than 2014 where just 25% outperformed.

Digging deeper into the source of this outperformance, Lyxor found a significant part could be attributed to five specific risk factors – low size, value, quality, low beta and momentum – which together accounted for 90% of portfolio returns.

European active fund managers, for example, were overweight low beta, momentum and quality factors during 2015, all of which outperformed benchmarks.

Lyxor’s research further compared active funds’ performance with minimum variance smart beta indices, which are designed to reduce portfolio volatility. Here the results were even more compelling: only 14% outperformed the smart beta index.

The research shows that smart beta strategies, which target these risk factors, are, on average, effective at outperforming traditional benchmarks. According to Lyxor, this justifies their increasing role as pillars of investors’ portfolios with growing assets under management to boot.

According to WisdomTree, smart beta ETF AUM is expected to push past $500bn by the end of 2016.

Lyxor believes smart beta strategies may provide effective tools for addressing specific challenges faced by investors today.  For example, investors are facing higher correlations between asset classes and between equity markets. It notes that different risk factors in smart beta strategies tend to exhibit relatively weak correlations with each other, providing an opportunity for investors to enhance diversification by investing across different factor strategies.

Source: Datastream & Lyxor Asset Management.

Source: Datastream & Lyxor Asset Management.

Furthermore, rising volatility in financial markets, within a context of diverging monetary policies and uncertainties concerning global growth, has increased the need for new tools to hedge or control these risks.

Additionally, quality income strategies may help investors address their search for income in an environment where government bond yields in several countries are at or near historic lows. These strategies screen stocks, bond issuers and even countries for indicators which suggest a greater ability to maintain attractive dividend yields or meet interest payments.

Source: Bloomberg & Lyxor Asset Management.

Source: Bloomberg & Lyxor Asset Management.

Commenting on the research, Marlene Hassine, Head of ETF Research at Lyxor Asset Management, said: “In today’s markets characterized by very low interest rates, higher volatility and no market trend in risky asset markets, investors need to look at new forms of portfolio allocation in order to find diversification and generate performance. Smart beta, which can be implemented, either with a more passive or a more active bias, is one of the new tools at the disposal of investors.”

If smart beta provides such significant value, should investors opt for portfolios that are 100% dedicated to these strategies?

Lyxor believes the answer to be ‘no’, noting that smart beta is not yet found on all indices and capitalization-weighted strategies still dominate the market. Furthermore, even though it shows significant potential for return, there are always a few active funds which outperform smart beta.

Guillaume Lasserre, Head of Active Investment Strategies at Lyxor Asset Management, explains what this means for an average investor: “We strongly believe that smart beta very adequately complements more traditional investment styles. In other words, we are convinced that combining traditional beta, smart beta and alternatives in a portfolio provides a very effective and powerful solution for the average investor.

“We believe we can safely recommend including up to 40% of smart beta in one’s portfolio allocation. Actually, we think combining 40% in traditional passive strategies, 20% in risk-based and fundamental smart beta, 20% in factor-based smart beta and 20% in alternative products might just be the most effective solution for both risk reduction and added performance.”

Lyxor currently has over $12bn in assets under management across its smart beta strategies which include their passive single- and multi-factor ETFs, minimum variance ETFs and quality income ETFs.

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