For investors wanting to make gradual shifts to de-risk their asset allocation, indexes offer the most cost-efficient way to express those tactical views.
For investors seeking large and constant equity exposure, we believe enhanced indexing is an attractive substitute for traditional indexing. Enhanced creates low tracking error portfolios by replicating the characteristics of a benchmark, while tilting the portfolio toward desirable attributes.
Compared to Enhanced Indexing, Smart Beta provides large, concentrated factor portfolios, with a high degree of active risk, giving asset owners effective tools to target desired factor exposures directly at the macro level of the total equity program.
Multi-Factor Smart Beta strategies can be considered reasonable substitutes for active management, but can also be used symbiotically with an effective active program as a completion portfolio
Once the core of the equity program is established investors can consider how to deploy active risk across equity managers. Here it is important to understand the differences between quantitative and fundamental managers and the relative benefits of allocating to them as satellite strategies:
Quantitative managers rank stocks based on various well-known and proprietary factors. But there are other qualitative attributes of a company that are less easily systematized and put into a ranking system. Because of this, quant managers take relatively small positions in many names, and require breadth in the universe they cover.
Fundamental managers also rank stocks but their analysis can rely less on quantitative methods and more on qualitative assessments based on fundamental company and industry analysis, company visits and ‘mosaic theory’. This research by its nature is intensive (and hence relatively costly) and so can be hard to apply across a wide range of stocks.