Smart Beta as an investment approach has grown appreciably over the last decade both globally and in South Africa. As we have built up the CoreShares business we have developed and launched a number of Smart Beta solutions. This is certainly a part of the indexing industry that is a key focus area for us.
One of my preferred Smart Beta strategies is the Dividend Aristocrats index. We have both an Exchange Traded Fund and a Unit Trust tracking this strategy under license with S&P. This is a simple, intuitive index approach which invests in stocks in the SA market which have maintained and / or grown their absolute dividends over the last seven years.
I believe this is one of the simplest ways of demonstrating how powerful Smart Beta can be. Such an investment style would have previously been left to the implementation of active managers at a significantly higher cost. However, given index development Smart Beta is able to capture the approach very succinctly. To quote the Financial Analyst Journal (Khan & Lemmon 2016): “What is new about Smart Beta is not the (investment) idea – but the simple and transparent packaging. Carving out and lowering the cost of one significant component of active management.”
The need for a Multi-factor approach
In the world of Smart Beta (or ‘factor’ based investing), Dividend Aristocrats would be considered as a quality factor strategy. This is one of the major factors most commonly referenced, the others include value, momentum, low volatility and size.
Although empirical evidence supports the success of long term allocation to these single factors, an issue which can arise when investing in any of these individual factor strategies (or active investment styles) relates to the cyclicality of returns relative to the market cap weighted benchmark and/or the sector concentration within the indices. For instance the Dividend Aristocrats has a high exposure to those sectors which tend to be the best dividend payers: banks, insurers, consumer staples, healthcare etc. Accordingly, we try to ensure clients understand the objective of the index so that if a period of underperformance does ensue there is no need for panic.
Notwithstanding the above and understandably many investment professional have been reluctant to make single factor allocations as they feel that they are not appropriately equipped to make such allocations and fear periods of underperformance may be prolonged which would be viewed poorly by their clients. Given this predicament CoreShares has embarked on a thorough assessment of Multi-factor indexes – indices which combine the proven factors together into one all-encompassing index. Such an index approach aims to achieve the best combination of factors as well as the best weighting techniques without risking over exposure to any single factor or sector.
Meet Scientific Beta – a commercial index house established by the highly reputable EDHEC-Risk Institute (France). The EDHEC-Risk Institute was one of the very first academic institutions in the field of fundamental and applied research for the investment industry. Scientific Beta is a beneficiary of the vast quantitative intellectual property developed within EDHEC which is now made available through Scientific Beta’s Multi Factor Indices.
As a direct response to the before mentioned predicament faced by many clients CoreShares has entered into an exclusive index license agreement with ERI Scientific Beta in the creation of a new flagship multi-factor strategy:
Scientific Beta CS South-Africa Multi-Beta Multi-Strategy Six-Factor EW Index.
This is a South African large cap multi-factor smart beta index incorporating six factors with multiple weighting strategies.
The objective of the strategy is to create exposure to well-rewarded, academically grounded risk factors, whilst diversifying away as much as possible from non-rewarded, non-systematic risks.
The solution is suitable for investors looking to incorporate a low cost, rules based, smart beta equity solution into their investment framework with an additional level of diversification by combining multiple factors and therefore smoothing the cyclicality that is typically associated with individual factors.
CoreShares aims to launch a Unit Trust fund based on this index in the second half of 2017. In the interim, the index is immediately available to institutional clients for segregated mandates.
CoreShares believes that investment strategies based on well-rewarded and academically grounded risk factors will start to play a much greater role in the asset management landscape in South Africa. This has already been demonstrated globally as investors increasingly seek a more transparent, rules based investment management environment at a lower cost.