If you believe marketing on smart beta you'd think there are hundreds of factors, SRP Americas

The challenge with smart beta strategies is how to translate the increased interest in equity risk factors into a retail structured products environment, according to participants of the Creating strategies & developing proprietary indices panel discussion at SRP's sixth annual Americas Wealth Management & Derivatives conference in Boston on June 15.

When we think about integrating smart beta we clearly think about the variety of different equity risk premia and how we can potentially capture those equity risk premia, said Matteo Andreetto (pictured), chief executive officer, Stoxx, who moderated the panel. "With smart beta there is this intersection between active and passive driven by two different forces. On one side there is the lower cost and on the other side the better performance," said Andreetto.

According to Ricardo Manrique, executive officer, MSCI, the index provider looks through a lens of six foundational equity risk factors and "those include momentum, volatility, quality, value, size and yield". "Everything that we do is build up from those factors. Do they deliver value? When you look at the data I think it is pretty easy to see that they do, whether it is in terms of outperformance or in terms of better risk adjusted returns."

What really determines how factor strategies are allocated depends on who the investor is and what their objectives are, according to Manrique. "Are they institutional or retail? Do they want outperformance or better managing of their risk budgets," said Manrique. "You could say the term smart beta, which we refer to as factor indices, is how you systematically extract that equity risk factor premium from returns over time in a passive way."

Rick Redding, chief executive officer, Index Industry Association, said he still sees a lot of confusion around the term smart beta. "Everyone now in marketing seems to call anything smart beta just because it gets recognised by the media," said Redding. "If you look at some of the marketing literature on smart beta you would think that there are hundreds of factors." The real question is really understanding what the underlying index does and is, according to Redding. "If you don't understand that then it is very difficult to say that all these strategies out there really do outperform," said Redding who noted that the last three years alone on average one smart beta ETF has come to the market each week.

I think I have got a pretty deviant view relative to the consensus how we use our factors, said William Park, managing director, head of Investment Risk & Strategy, UBS Hedge Fund Solutions. "Most people live in what they call the pure risk premia space. They want things that are very persistent, consistent across different asset classes, and very well supported in academia," said Park who admitted that, whilst appreciating that approach, he thinks that the broader QIS (qualified investor scheme) universe can go much further than that.

"Where we are most excited is the convergence between true hedge fund strategies versus the more academic implementations," said Park who noted that on the leading edge of the QIS space they may have run ahead of academia. "I think what's interesting is that hedge funds by nature are secretive and do not want their proprietary methods to be widely known, so to wait for academia to catch up, I think is maybe the wrong approach."

According to Redding many of the things that make the hedge funds successful cannot be replicated in a way the academic wants to do those studies. "I think there is a lot there when you start thinking about merging the hedge fund and QIS space but I am not sure academia will catch up."

Park thinks that the real opportunities are in areas that do not fit very cleanly in the six factor strategy descriptions. "From a risk reward perspective I find those niche strategies, the customised strategies, to be more effective. I find those potentially to have higher sharp ratios than some of the more simple strategies."

Andreetto asked the panel to what extent, when it comes to allocating capital, they prefer the uniqueness of the QIS compared to the transparency an index actually might give you.

"I view transparency as having access to the information of the underlying securities in a strategy, having access to the rulebook," said Park who noted that this does not mean that the rulebook needs to be publicly disclosed. "I don't think transparency means necessarily easy to understand. If the end investor can embrace complexity that could potentially lead to better outcomes."

Everyone should have access to the methodology and talk about the universe of securities that are included, agreed Redding. "There is intellectual property that I don't think anyone should have or should give away but at least you are defining your methodology and defining some of the groupings or securities that you use," said Redding.

According to Manrique there are clearly opportunities where quantitative index strategies which are more sophisticated may be slightly less transparent in terms of how they are being achieved. "It really depends on who the investor is and what they are trying to achieve. They should have available a toolkit which could include equity factor indexes from index providers and/or quantitative index strategies from proprietary index providers."

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