Diversity wins : Persistent investor interest in smart beta, particularly within diversifying strategies

Willis Towers Watson’s institutional investment clients globally allocated $10bn, via 175 selections, to diversifying investment strategies in 2015. Within this grouping, liquid alternatives attracted the most interest with over $8.1bn, of which approximately half is in smart beta and where $1.9bn is in secure income strategies.

Luba Nikulina, global head of manager research at Willis Towers Watson, said: "Given where we are in the investment cycle, our clients have continued to diversify their portfolios to protect against downside risks while also rotating towards higher-skill mandates to take advantage of the increased market volatility. Clients continue to use smart beta solutions, as reflected in the high number of selections, which utilise systematic approaches to exploit those alternative-risk premia that provide true diversity beyond equity and credit. In addition, secure income strategies proved very popular last year as even de-risking clients are happy to embrace illiquidity if it provides them with some liability matching characteristics."

The data also shows that last year Willis Towers Watson’s clients – which include pension funds, sovereign wealth funds, endowments and foundations and insurance companies – carried out 215 credit selections totalling almost $18bn, of which a significant proportion remains in higher-quality credit ($5.9bn in global bond mandates and $3.3bn in US mandates).

Luba Nikulina said: "Even in higher-quality credit, we observed a move towards solutions with superior downside protection. Last year we recognised more value in high-quality structured credit over vanilla investment-grade corporate credit, driven largely by regulatory factors. We sought a way to capture this opportunity and helped structure an exclusive implementation option for our clients which attracted over $5bn of client capital in 2015."

The company’s clients invested $6.6bn in alternative credit mandates in 2015, of which $1.4bn was in credit hedge funds and $1.3bn in illiquid credit. The number of selections in alternative credit (98) more than doubled compared to the prior year.

Luba Nikulina said: "Alternative credit was underexploited by investors in the past, both in terms of asset allocation and implementation efficiency. However, this is changing and last year we conducted a record number of alternative credit searches as many clients sought to reduce reliance on the equity risk premium, improve diversity and bring additional sources of return to their portfolios."

Within equities, global mandates, totalling around $8.2bn, continued to be the most popular with Willis Towers Watson’s clients in 2015, followed by Australian equities ($3.1bn) and a record amount of new capital was allocated to equity smart beta strategies ($2.6bn). During the year emerging market equities attracted $2.2bn while $3.0bn was invested in US equities. After significant capital deployment in private equity in 2013, the company’s clients favoured more niche illiquid strategies to a more traditional buyout approach and as a result private equity attracted fewer assets than in previous years ($500 million). In total, equity mandate selections in 2015 accounted for $21.5bn in assets via around 250 selections.

Luba Nikulina said: "Widely spread de-risking has caused a decline in traditional equity searches, along with fewer like-for-like mandate replacements. Instead, allocations are getting more strategic with more substantial shifts, resulting in a greater average allocation size than in previous years. The region-specific allocations have been largely driven by tax and regulatory considerations. Equity smart beta has continued to be very popular as a way to improve our clients’ equity market exposure, with two and a half times more capital allocated to this strategy last year compared to the year before."

During 2015 Willis Towers Watson’s institutional investment clients globally carried out over $7bn of selections across various types of smart beta strategies, bringing the total exposure to around $46bn across a range of asset classes.

Luba Nikulina, said: “It is positive that investors are thinking smartly about betas across all return drivers in their portfolios. However we are genuinely concerned about the proliferation of products claiming to be smart beta, particularly in the equity area. Not all smart beta is created equal: it should be easy to describe and understand but many labelled products are not, are often poorly implemented and seem naïve about the inherent risks. Investors should beat a smart retreat from these.”

Investment manager selection activity globally at Willis Towers Watson reached over 730 selections in 2015, reflecting around US$60bn of assets for over 270 clients.