Alternative beta and risk premia strategies are gaining momentum in the structured products market because of their focus on risk management as opposed to performance, according to panellists during the Indexing and Client Co-creation: Aligning Algorithms, Asset Allocation and Outcomes panel at the 15th Annual Europe Structured Products & Derivatives conference at the etc.venues, County Hall, in London.
Walter Cegarra (pictured), global head of structuring for quantitative investment strategies (QIS) at Credit Suisse, said that on top of delivering premia, systematic strategies are helping to manage investor expectations and change the way asset managers look at asset allocation.
"Investors are now looking at factors instead of asset classes," said Cegarra. "Smart beta is driving a shift around asset allocation and replacing fixed income to add protection to investment portfolios."
Smart beta has also revolutionised indexing in the same way leverage did when it was introduced to the market. "The question is if it will blow up as we have seen with leverage," said Gareth Parker, consultant, index product and governance specialist at Bovill.
According to Daniel Ung, SPDR senior ETF strategist at State Street Global Advisors, smart beta is also forcing index providers to explain the investment process (ratios, ...) as opposed to just aim at outperforming a benchmark because investors are a lot more savvy.
"Index providers serve a wide variety of clients and needs and they have to understand that for an ETF the tracking error of the index is a very important factor at a product development level whereas this is not as important for a structured product," said Ung. "Also, institutional investors want exposure to single factors while private banks want to use multi-asset strategies as a way to manage risk and add overlays to the underlying such as ESG."
From a product development perspective, smart beta is also providing cheaper optionality which in the current context of low rates, low yield and low volatility helps to deliver capital protection and better upside, according to Cegarra.
Mifid 2 will improve communication between product manufacturers and distributors, which will also help to establish the interaction between payoffs and underlyings, and the best way to deliver the strategies. Smart beta has also opened opportunities for investment banks to leverage their structuring capabilities but asset managers are now pushing innovation by promoting co-creation.
"It's not about replacing positions with smart beta strategies but about finding the right sources of beta (and alpha) via swaps, etc. during the asset allocation process," said Oumar Diawara, managing director, structured investment services platform at Natixis Asset Management. "We work closely with our clients to find the most efficient vehicle/wrapper to deliver the underlying strategy. The wrapper is very important in many cases and regulation is providing new opportunities to deliver strategies in different ways."
According to Ung, the underlying strategy is the first consideration while the wrapper comes second. "For us, having strong fundamentals on the underlying strategy is key," said Ung. "We favour physical replication because it's what clients demand but synthetic replication is also a way to deliver strategies around assets that are more difficult to replicate."
Co-creation has also helped to fine tune risk premia strategies to address specific needs and investment goals, according to Cegarra. "Asset managers now approach us not with a product request but with a specific demand such as infrastructure for execution, and we can also provide that," said Cegarra. "They don't want to talk about how the index is created but about how they can execute the trade."
Going forward, indexing will benefit from the upcoming benchmark regulation which is expected to impact on creation and delivery, the panellists agreed.
"Indexing will become more expensive because of regulation and this will encourage product innovation," said Parker, adding that the new requirements around index administration will become relevant for structured products providers and asset managers. "The lack of awareness around new obligations could raise problems and the regulatory fines can be hefty."
New methodologies, the granularity of the strategies and the slice and dice approach in the indexing space has resulted on the number of indices now being greater than the number of stocks. "The need for education has increased," said Cegarra. "Clients are more specific on governance and this will keep providers of underlying strategies on their toes, as they will need to justify position taking."