Comment: Check your nest eggs but only for ‘smart beta’

Bill Jamieson
Bill Jamieson
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IT’S time, it seems, to fill your boots with “smart beta”. This is the new, or nearly new, “must-have”. It certainly sounds better than “dumb alpha”.

A high-powered investment seminar in Edinburgh last week organised by Broadgate Maitland and Scottish Investment Operations centred on “the value of active management in the new normal of low returns” or to cut to the chase: are active fund managers any use?

The expert panel comprised Harry Morgan of Thomas Miller Investment, Colin McLean of Scottish Value Management, Mark Johnson of iShares Blackrock, Ken Barker of Baillie Gifford, and Money Week editor Merryn Somerset-Webb. All was going swimmingly until Somerset-Webb, a notable critic of active fund management and its associated fees and expenses, came to speak.

She had some electrifying suggestions for the industry. All male fund managers should be sacked and the business of investment management entrusted to women with three children of nursery age.

Her critique went to the heart of a frequent criticism made of the fund management industry: its earnest, relentless chopping and changing and “churning” of shares in an investment portfolio, born of an obsession with daily movements in markets.

Some funds can experience churn rates of 20 per cent and more over a 12-month period with little evident improvement in overall performance.

The one sure way round this, in Somerset-Webb‘s view, is to trust fund management to those who are not constantly obsessed by day-to-day movements in markets and who have other better things in life to do.

I had an impression that this did not exactly cut it with her fellow panellists and the rows of Edinburgh New Town suits in the audience. It reminded me of that wise advice for retail investors that rates of investment happiness are in inverse proportion to the number of times we check up on our nest-eggs.

If you check once a day or even more frequently, the result is anxiety. A check-up once a quarter will be only slightly less calming. A check once a year should bring some peace of mind. A check once in five years is the one most likely to bring happiness.

Perhaps Somerset-Webb should also have recommended that her fund managers, in addition to going part-time and minding three children while running stock market funds, should also wear blindfolds to improve their investment performance.

The discussion centred on the difficulty that many actively managed funds have in outperforming their benchmark indices despite the fees charged for management. Indeed, the fees and charges often condemn funds to persistent under-performance. Was it not the case that many of us would save a lot of money on fees and charges and actually do better simply by buying and holding passive or index-tracker funds?

But the problem with these is that they automatically invest in large companies that have seen the best of their growth in their progress to the FTSE-100 and cut out smaller-to-mid cap companies where growth outperformance is be found. The result is an investment approach that effectively buys in at the top and automatically invests in large-cap companies such as natural resource stocks that have not performed at all well over the past year as the commodity cycle has turned. It overweights mature companies and under-invests in smaller and faster-growing ones.

Several panellists sang the praises of the alternative, or “smart beta”, approach instead of buying and holding. So what is smart beta? It covers a range of investment strategies that avoid the conventional approach of buying companies on the basis of size. The approach uses alternative weighting schemes based on particular sectors such as utilities or consumer staples, or by value criteria or dividend performance.

Such funds have gained in popularity in the wake of the 2008-9 market crash and the desire by investors for funds that are less volatile or which reduce risk. Investing in this way has potential to outperform the original benchmark index and is cheaper than paying an active manager to trade FTSE-100 stocks.

Smart beta can also enable investors to gain more controlled diversification by using funds that track specific sectors such as property, venture capital or emerging markets.

Once the parameters have been set, the manager passively follows the index for that particular universe. It costs less than active management. And with more specialist tracker funds to choose from, the extra fees and charges of conventional specialist funds can be avoided.

Somerset-Webb’s choice – the iShares FTSE UK Dividend Plus managed by BlackRock, provides a good example. This is an exchange traded fund that aims to track the performance of the FTSE UK Dividend+ index as closely as possible. It offers exposure to the 50 highest yielding UK stocks within the universe of the FTSE 350, excluding investment trusts. Stocks are selected and weighted by one-year forecast dividend yield. It looks a smarter than average smart beta – whether you have three screaming toddlers or none.