Taiwan's biggest pension manager is embracing and pushing for smart beta ETFs.

Taiwan's Bureau of Labor Funds (BLF), which runs one of Asia's largest pension schemes, is encouraging Asian institutional investors to consider smart beta investing.

Its initiative reflects the growing trend among Asian asset owners to use smart-beta and customised indexes.

The BLF introduced its first smart-beta strategies in 2011. Over the past few years, the bureau has been stepping up to diversify its passive investment portfolio away from local or overseas equities assets into environmental, social and governance (ESG) and multi-asset investing.

A BLF's spokeswoman said the bureau decided to enter into smart-beta strategies as the strategies are able to address the shortcomings of traditional equal-weighted indexes and can deliver better risk-adjusted returns.

Meanwhile, the bureau is shifting the benchmarks for its smart-beta strategies.

The BLF used single-factor indexes such as low volatility, high dividend, and high quality as the benchmarks for smart beta mandates initially.

"However, we found that single-factor indexes can be easily affected by short-term market volatility. As well, it's not easy to select the appropriate indexes," the spokeswoman points out.

As such, the BLF has collaborated with index providers to create the indexes best-suited to its investment objectives in recent years.

The first one was in 2016, when BLF and MSCI jointly compiled the benchmark index for its Asia Pacific mixed equity mandate. Last year, they created the benchmark for the BLF's first overseas ESG mandate.

Earlier this year, BLF worked with Taiwan Stock Exchange subsidiary Taiwan Index Plus Corp and UK-based index provider FTSE Russell to create the benchmark for its first local ESG mandate.

According to the BLF spokeswoman, there are many advantages in using a customised index.

"For the Asia Pacific mixed equity index, we created an index that combines enhanced value, high quality and low volatility factors," she says, adding that the risk characteristics and performance measurement of the index is more accommodative of a pension fund's investment objective compared to existing mixed equity indexes.

"Likewise, the ESG underlying index we compiled is not only capable of filtering out 'sinister' industries, but it can also improve the performance of our ESG mandate," she says.

Indeed, customised indexing has become more widespread in the institutional space because of its transparency.

Many institutions are increasingly expanding their goal to meet overall investment objectives to include ESG elements, according to Johnnie Yung, head of portfolio strategies for Asia ex-Japan at State Street Global Advisors.

"In response, index providers have created a wide range of customised indices such as green energy and gender diversity," Mr Yung notes.

Mr Yung says such indexes can be designed to meet an investor's specific investment objective, where risk profiles can also be customised while maintaining the transparency and cost efficiency of indexing.

According to Marius Baumann, managing director, global custom index product management at S&P Dow Jones, the current essential investment themes and trends for Asian institutional investors are higher yield, stable dividend income, and currency hedging.

"A custom index approach gives index issuers "freedom to run their strategies in house while outsourcing to an independent third-party calculation agent," Mr Baumann notes.

"Looking ahead, we will continue to look into innovative index customisation. We will press ahead with the partnership with index providers in order to create the best interest for the pension (funds)," the BLF spokeswoman says.

The BLF currently has more than NT$3.6 trillion (US$123.5 billion) in total assets under management.