Seven Investment Management has overhauled its smart beta strategy across its multiple multi-manager ranges.
The group has implemented smart beta strategies for nearly two years across its active Multi-Manager and passive AAP ranges in a bid to get cheaper exposure to equity markets, but in a more targeted way than a conventional tracker or passive fund.
Now it has refined and improved the formula to include a scoring system for factors such as undervaluation.
Smart beta products vary from traditional trackers, which aim to simply replicate the make-up of a benchmark index such as the FTSE 100, by, for example, equally weighting constituent companies rather than weighting them based on market capitalisation.
Justin Urquhart Stewart, co-founder of 7IM, said the company’s most favoured smart passive strategy had been to use an equally-weighted index.
When rebalanced after a short period back to equal weights it was “enough to address a great deal of price inefficiency”, as overvalued companies were being sold and the proceeds reinvested in undervalued companies.
“Conventional indices, by comparison, allocate weights in line with the size of a company’s market value,” he said.
“They retain all price inefficiency by always reflecting the current market value of companies, whether they be temporarily overvalued or undervalued.”
Mr Urquhart Stewart said his equal-weighted investments
had outperformed conventional benchmarks by “about 3 per cent in the past year”, which he said was similar to the outperformance of the equally-weighted version of the S&P 500 index versus its standard peer.
But Mr Urquhart Stewart said the group had recently developed a “more sophisticated approach” in using smart beta.
“An equally-weighted index is good at avoiding price inefficiency but it also tends to favour companies that are simply small rather than large,” he said.
“This is not necessarily a problem: there is plenty of evidence to show that smaller companies outperform larger companies over the long run.
“However, investing in smaller companies entails more risk. Moreover, as smaller companies have significantly outperformed larger companies over the past few years, we are currently less keen to bear that risk.”
Mr Urquhart Stewart said to avoid such “unwanted risks”, the group had developed a system which scores companies according to whether they are likely to be over or undervalued, whether they be small or large.
“By scoring them this way we are able to locate the companies and the characteristics we want with greater precision,” he said.
“We also score them for other risks that we may not want to include in our smart passive strategy – for example, we try to avoid companies that are ailing and unlikely to recover.
“The result is a smart passive strategy with better prospects for outperformance, plus better control of risk.”
Mr Urquhart Stewart said he had initially applied this approach to European stocks, with such smart beta holdings noted on the funds’ factsheets as a ‘basket of European equity – Value Strategy’.
He added the funds did not levy any extra charges for implementing the smart beta strategies, “in spite of the considerable time and expertise required to develop and implement the strategy”.
