Weixu Yan, head of ETF research at Close Brothers Asset Management (CBAM) speaks to ETF Stream’s deputy editor Tom Eckett on balancing high beta exposure such as cybersecurity and cloud computing with low volatility, how to utilise multi-factor ETFs and why value and growth strategies are not of interest.
Yan joined Close Brothers following the acquisition of Fortune Asset Management in 2010. He runs a number of multi-asset portfolios at the firm.
Do you use smart beta or factor products within your portfolios?
First of all, along with many of my peers, I do not like the term ‘smart beta’. It is not very descriptive, and we certainly prefer the term ‘factor-based indices’ or ‘factor ETFs’.
We use factor ETFs across our range of funds at CBAM. Generally, this is to adjust equity risk exposure of the funds, rather than looking for something to outperform the broad market indices.
How much of your portfolios does smart beta typically make up?
The proportion of factor ETFs invested in the portfolios depends on the market environment, the portfolio composition at the time, and whether the factor ETF actually provides the exposure that we want.
Generally, this means they make up around 10-20% of a portfolio. For example, when markets are highly uncertain, there will be take-up of defensive, low volatility ETFs.
Sometimes we might have a strong view on a certain factor, but the ETFs available might not provide that exposure; therefore, depending on how closely the ETF tracks the factor we want, we vary the position accordingly. As our funds are well positioned, we are not looking to further increase our allocation to factor ETFs.
How do you view smart beta/factor-based ETFs?
As the range is mainly invested in ETFs and index tracking funds, we view factor-based ETFs as part of the passive toolkit. We utilise them to best express our asset allocation and investment decisions.
Which parts of the smart beta spectrum interest you most at the moment?
I am currently interested in the low volatility factor. We have increased our allocation to more ‘high beta’ themes and sectors, like information technology, cybersecurity, and cloud computing.
In order to prevent the funds from becoming overly risky, we have combined them with the low volatility factor as a counterbalance.
I find value and growth less compelling. In this macro environment, they seem to lack clear investment rationale, whereas it is possible to get growth exposure directly from sector or theme ETFs which have clear and specific rationales and exposures.
When you focus on a particular smart beta product to invest in what factors do you take into account?
The most important thing I think about when considering a factor product is the index methodology. The most important aspect is to analyse whether the product provides the exposure that we want;
if it does not then we consider whether there is something else that does, and whether we are looking for strong or weak factor strength. To do this, it is vital to conduct thorough research in order to understand how each index is constructed i.e. how the stocks are chosen, weighted, and the frequency of rebalancing.
The fund structure or the wrapper is there to provide tracking to this index – it is often only a secondary consideration.
Tracking error is important when there are multiple products to choose from which track the same index, but if there is only one product tracking the index that best fits our investment view then we would rarely discount it solely due to tracking error.
Alongside smart beta, we have also seen the rise of thematic ETFs. Does this interest you?
Absolutely, thematic investing using ETFs is of great interest. Caution is warranted, however, as thematic ETFs are likely to have little backtesting or backing from historical data, while factor investing tends to be based on exactly that.
But just because thematic investing using ETFs does not have as much academic backing, it does not mean it does not work.
We are in a very different world post-pandemic and have learnt to always look to the future and use forward looking data to complement the historic data we already have. As such, thematic investing like cyber security and cloud computing resonates quite well. One way to think of them is ‘sector investing 2.0’.
However, similar to factor investing, the investor needs to understand the investment thesis; how the stocks are chosen, and thus whether you are getting the exposure you want. There can be even more discrepancy between providers’ themes in this space, so research and due diligence are key.
Are you concerned by the recurring accusations of data mining levelled at all factors and smart beta strategies?
These issues are a concern and should be to everyone in the industry. Most factors are derived using historical data, and as such are susceptible to data mining. It is now an even bigger issue as algorithms have become more sophisticated and computers efficient, allowing researchers to run multiple calculations simultaneously.
When ‘new’ or claim of ‘more robust’ factors are presented, it is vital to question that data used and really delve into the details. We prefer simple factors which present fewer data mining opportunities, that work just as well to adjust for equity volatility. The risks grow when trying to find an edge of out-performance.
How do you engage with clients about smart beta? Is there any interest and if there is interest do clients raise any concerns?
Because we use factor ETFs primarily to adjust for equity volatility, we have not seen any client concern around the issue.
Generally, we try to use factors which are intuitive and can be understood by common sense, rather than needing to conduct rigorous statistical testing when the robustness of the factor is doubtful. Complexity does not equal performance; sometimes, simplicity is best.
Are there any specific areas where you would like to see new products emerge?
Fixed income is an interesting idea, but due to the return dispersion within the asset class it does not seem to allow as much of slicing and dicing as its equity counterparts.
What I am more interested in are the alternatives or diversifiers from equity and bonds. Of course, this is a small allocation in general and so does not get as much focus from the large ETF providers, but it is a fascinating area for the future.
Does multi-factor investing interest you?
Yes, even more so than the single factors. This is because I do not believe you can isolate factors in the long-only space.
It is better to expect the product to be exposed to multiple factors, rather than believe it is providing isolated single-factor exposure; as an investor, this means you are aware of the unintended factor exposure that you might get exposed to. For example, we have previously invested in a product that provides high dividend and low volatility; as this product provides exposure to more than one factor, I consider it multi-factor.
By 2025 do you think you will be making extensive use of smart beta products and factor ETFs?
We are already using factor ETFs extensively within the risk parameters and framework set here at CBAM, which is a sensible route that meets our clients’ needs. Unless those frameworks change, I imagine we will stick to our current usage.
Weixu Yan is an investment manager and head of ETF research at Close Brothers Asset Management
This article first appeared in the Q4 2020 edition of Beyond Beta, the world’s only smart beta publication. To receive a full copy, click here.