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Alpha Smarter Than Beta

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Global professional services company Towers Watson’s (NYSE, NASDAQ: TW) institutional investment clients globally allocated over $8 billion to smart beta strategies during 2014, bringing the total exposure in these strategies to around $40 billion (in 550 portfolios), across a range of asset classes. This compares to its clients having a $32 billion exposure to smart beta strategies at the end of 2013, and $20 billion in 2012, according to the company’s global investment manager selection data.

“Smart beta growth has been phenomenal in the past five years, and we expect to see continuing demand, especially for smart implementation and innovation, which define the top managers in this space,” said Brad Morrow, North America head of manager research at Towers Watson.

The data show that last year, Towers Watson’s clients (which include pension funds, sovereign wealth funds, endowments and foundations, and insurance companies) carried out diversifying strategy* selections worth $10 billion, up from $7 billion in 2010. Among diversifying strategies during 2014, real estate attracted the most interest (over $3 billion, compared to $1.6 billion in 2010), with one-tenth in smart beta, followed by infrastructure ($2.3 billion, compared to $59 million in 2010), with one-third in smart beta. In the same period, liquid diversifying strategies attracted $1.7 billion, of which more than one-third is in smart beta.

“We encourage our clients to increase diversity in their portfolios and think about solutions holistically in the context of all return drivers. However, increasing diversity works well only if accompanied by the right level of governance that can identify skilled asset management and ensure cost control, both of which are crucial for achieving successful outcomes,” said Morrow.

According to the data, credit selections by Towers Watson’s clients in 2014 totaled $34.8 billion (compared to $19.3 billion in 2010), of which the majority were invested in global bond mandates ($12 billion, compared to $5 billion in 2010), followed by U.S. mandates ($7.3 billion, compared to $3.5 billion in 2010) and Australian bonds ($3.4 billion, compared to $2.3 billion in 2010). In 2014, $4.5 billion was invested in developed-market alternative credit mandates, and $400 million in direct lending and structured credit opportunities. During the year, $1.5 billion was invested in smart beta in the bond area, compared to $500 million in 2010.

“Investors in credit want to capture beta efficiently, and improve implementation of thematic and tactical views through opportunities such as alternative credit and direct lending. This allows them to broaden their exposure to the illiquidity and skill premiums, and improve credit portfolio effectiveness,” said Morrow.

In equities, global mandates, totaling around $7 billion, continued to be the most popular with Towers Watson’s clients in 2014 (compared to $4.5 billion in 2010), followed by U.S. equity ($3 billion, the same as in 2010), U.S. small-/mid-cap equity mandates ($2 billion, compared to $1.5 billion in 2010). During the year, emerging-market equities attracted $1.8 billion (compared to $3.2 billion in 2010), while $1 billion was invested in global ex-U.S. equities (compared to $1.6 billion in 2010). The company’s clients invested $500 million in long/short equity in 2014, compared to $200 million in 2010.

“Perhaps unsurprisingly, smart beta innovation in the bond space has been slower than in equities, partly due to the nature of the indices and the level of complexity that comes with the territory, but this is changing, and we think there is more to do in bonds. In terms of smart beta, bonds are where equities were five years ago,” said Morrow.

After significant capital deployment in private equity in 2013, Towers Watson’s clients favored more niche, illiquid strategies to a more traditional buyout approach, and as a result, private equity attracted fewer assets than in previous years ($415 million, compared to $714 million in 2010). In total, equity mandate selections in 2014 accounted for $20.3 billion in assets (compared to $20.6 billion in 2010), with smart beta accounting for $1 billion, compared to $45 million in 2010.

“The negative sentiment toward active management may be somewhat overblown now. We believe in good active management but acknowledge it is very difficult to find,” said Morrow. “If investors’ governance levels are appropriate, and they believe they can identify skill, now is a good time to be looking for alpha given increasing market volatility and the lack of clear beta opportunities. Somewhat ironically, smart beta has sharpened and refined active management to be truer than it used to be.”

Investment manager selection activity globally at Towers Watson exceeded 880 selections in 2014, reflecting around $72 billion of assets moved for over 300 clients. This compares to assets moved of around $57 billion, for around 790 selections, in 2010.

Towers Watson Investment

Towers Watson’s Investment business is focused on creating financial value for institutional investors through its expertise in risk assessment, strategic asset allocation, fiduciary management and investment manager selection. It has over 800 associates worldwide, assets under advisory of over $2.2 trillion and over $75 billion of assets under management.

About Towers Watson

Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 15,000 associates around the world, the company offers consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Learn more at towerswatson.com.

*Diversifying strategies provide investors with exposure to diversifying risk premiums and include real estate, infrastructure, real assets, systematic, macro, reinsurance and alternative betas.

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