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Low-volatility strategies are gaining speed in Asia

Early success of large pension funds has encouraged other institutional investors

062413 kouta
Yoshinori Kouta says early success has encouraged other investors.

Demand in Asia for equity strategies focused on low-beta stocks should pick up during the remainder of 2013 following a year or two of study by institutional investors in the region, market veterans say.

One measure of whether those strategies — which aim to match or exceed market-capitalization-weighted index returns with a fraction of the volatility — are becoming more mainstream will be how well they fare in global equity searches by big institutional investors in key markets such as Japan and Korea.

Institutional sales executives in the region say bulge-bracket institutional investors in Japan — including the 112 trillion ($1.182 trillion) Government Pension Investment Fund, the 10 trillion National Pension Association and the 8 trillion Federation of National Public Service Personnel Mutual Aid Associations — are poised to conclude searches for global equity managers in the coming months.

In a telephone interview, Tokihiko Shimizu, director-general of the GPIF's research department, while declining to discuss timing, said his team is engaged in an in-depth study of low-volatility and other “smart beta” strategies, to gauge the potential for diversifying the 80% of the pension fund's more than US$300 billion in domestic and international equities allocated to passive market-cap-weighted index strategies.

A National Pension Association spokesman, meanwhile, said the NPA is also studying managed volatility strategies, but declined to say whether allocations could eventually follow.

A spokesman for the Federation of National Public Service Personnel Mutual Aid Associations declined to comment.

Tide turning

For now, the Asia-Pacific region continues to account for only a fraction of mandates reported by managers of low-volatility and minimum-volatility strategies, well behind the level of interest from investors in Europe and the U.S.

For example, European investors accounted for $2.5 billion of Boston-based Acadian Asset Management LLC's $4.4 billion global minimum-volatility strategy as of March 31, followed by U.S. investors with $834 million, according to eVestment LLC, Marietta, Ga. Acadian's strategy is the largest active “smart beta” offering in eVestment's database. From the Asia-Pacific region, Australian investors accounted for US$485 million while Japanese investors contributed $367 million.

But there are signs the tide might be turning.

Earlier this year, Taiwan's US$52 billion Labor Pension Fund, Taipei, became the first big institutional investor in the region to allocate a significant chunk of its portfolio to minimum-volatility strategies.

Following a mid-2012 announcement that it would invest US$1.5 billion in MSCI minimum-volatility indexes, the LPF in April awarded its first such mandates of US$125 million apiece to index strategies run by Boston-based State Street Global Advisors and New York-based BlackRock (BLK) Inc. (BLK)

Those allocations followed a $1.2 billion allocation over the past two years to a FTSE RAFI All-World 3000 index — bringing the LPF's combined “smart beta” allocations to more than 40% of its foreign equity allocations for the pension fund's US$20 billion, defined benefit “old scheme,” and more than 20% for its US$32 billion, defined contribution “new scheme.”

Money managers and index providers see the momentum continuing to build this year.

For big institutional investors, strategies such as minimum volatility have become a “third category,” alongside pure beta and pure active strategies, and investors in Asia have been giving them the same level of scrutiny they'd give an active strategy, noted Theodore Niggli, the Shanghai-based head of MSCI's index business for the Asia-Pacific region. Interest among large institutional investors is clearly picking up, he said.

The low-/minimum-volatility conversation in Asia has gone well past the “tell me what it is” stage to detailed discussions of how active a manager's strategy is and the nitty-gritty details of what a firm's portfolio managers are doing, said Alexandra Solnik, the Hong Kong-based Asia-Pacific head of BNP Paribas Group quantitative equity affiliate THEAM.

5% of low-vol AUM

Pension funds in Japan and other countries in the region account for perhaps 5% of THEAM's more than US$1 billion in low- and minimum-volatility assets under management, but their weight should grow, said Ms. Solnik, who just returned from meetings with institutional investors in Hong Kong, Singapore, Japan, Korea and Taiwan.

Institutional investors in the region have done their homework, and with big funds in markets such as Korea, Japan and China recently announcing higher allocations for domestic and international equities, a growing number could adopt some “smart beta” in upcoming allocations, agreed Jesse Pak, Hong Kong-based director, Asia, for the FTSE Group.

Investment consultants see a similar trend. It has been almost two years since Mercer began recommending low-volatility and minimum-volatility strategies as the low-risk anchor of a barbell-type portfolio in Asia, and the first adopters in Japan have enjoyed enough success to prompt a larger number of midsize and smaller clients to move as well, said Yoshinori Kouta, Tokyo-based partner and head of investments for Mercer's Japan business.

If so, that growing interest has come despite performance this year that has trailed market-cap-weighted indexes, in line with the logic that those strategies gain by losing less when markets slide, even as they're expected to lag when markets are running.

The month before the recent market correction, when high beta stocks did very well, was one of the toughest on record for low volatility and managed volatility strategies, said Harindra da Silva, president of Los Angeles-based quant boutique Analytic Investors LLC. The recent market correction has led to the recovery of some of that lost ground, he said, noting that “choppy markets are really beneficial for the strategy.”

In 2011, when equity markets surged and tumbled in alternating risk-on, risk-off environments, low- and minimum-volatility strategies crushed market-cap-weighted benchmark returns.

For example, Acadian's global strategy beat its MSCI World benchmark by 13 percentage points in 2011, before trailing a 16% gain for the benchmark in 2012 by more than 300 basis points. Likewise, Analytic Investors' $1.6 billion global low-volatility strategy exceeded that same benchmark by more than nine points in 2011, before giving back 3.5 points in 2012.

Market reminder

The latest market volatility can only serve to remind investors in Asia about why they were paying attention to low- and minimum-volatility strategies in the first place, said Paul Hoff, the EDHEC Risk Institute's business development director, Asia-Pacific, from Tokyo, where he is setting up a new office.

If strategies that take advantage of the low-volatility anomaly are gaining adherents, the degree to which institutional investors in Japan continue to focus on benchmark-relative returns, as opposed to risk-adjusted returns, remains a hurdle for many, said Charles J. Yang, director and chief investment officer with Tokyo-based T&D Asset Management Co. Ltd.

With a number of potential clients still leery of gaining only 48% when the market is enjoying a 50% surge, Mr. Yang said his firm in the next few months is bringing out absolute-return strategies focused on low volatility to alleviate such concerns.

He said the first offering, expected to be launched in July with a $20 million seed investment by a Japanese corporate pension client, will be a “beta arbitrage” strategy subadvised by quant boutique Martingale Asset Management LP, Boston. It will have a 120% long position in U.S. low-volatility stocks and a 60% short position in U.S. high-volatility stocks. Mr. Yang declined to name the client.

In an e-mailed response to questions, William E. Jacques, Martingale's CIO, said with beta of close to zero, the benchmark for the strategy is LIBOR and the tracking error issue “disappears.” Meanwhile, “if returns to low-risk stocks are similar to high-risk stocks, we'll capture 60% of the equity risk premium without the stock market risk,” he said.

Mr. Yang said T&D in August will bring out a Japanese equity strategy of its own based on the low-volatility anomaly, with 100% exposure to low-beta equities and a beta of roughly 0.7, offset by a 70% short position in Japan's Topix index futures. That strategy, too, will start with seed money from another Japanese corporate client, said Mr. Yang, declining to identify the client.

Mr. Yang said T&D could eventually look to offer its absolute-return oriented low-volatility strategies more broadly in Asia, in tandem with the firm's strategic partners in the region.

This article originally appeared in the June 24, 2013 print issue as, "Low-volatility strategies are gaining speed in Asia".