(pictured: Paul Bouchey)
With all the noise around factor investing and its various nom de plumes, such as smart beta and risk premia, the assumption always seems to be that it’s inherently efficient from a transactions perspective. Well, it’s not.
In a paper published this month by Parametric Portfolio Associates, which is an after-tax and implementation specialist global manager, the firm says there are many inefficiencies in factor investors which come about because of unintended factor bets. They can “load a portfolio with unwelcome surprises”, the paper says.
In Sydney last week, Paul Bouchey, Parametric’s Seattle-based CIO, said that tax-managed and other pure factor investing strategies are what super funds should be looking at. Factor investing is not as simple as it seems.
“Investors have to be aware, too, of money which may pile into a factor,” he said. “For instance, people say they love low volatility [as a factor] but it’s really expensive right now. So, what we do is design a portfolio so they can have their cake and eat it too. We can construct a portfolio which is low-vol but also neutral on valuations [price]. It means that investors are less worried about market timing.”
Bouchey says that factor investing is a “commoditised version” of active investing. “We’re an implementation manager,” he said. “And we can build portfolios which accommodate all factors, and we do it efficiently from a tax and other costs’ perspective.”
Raewyn Williams, Parametric’s Sydney-based director of research and after-tax solutions, described after-tax factor investing as “formula one”. When people replaced some of their active strategies with passive ones, they thought they were getting tax efficiency. Not necessarily,” she said.
Parametric produced a landmark paper (‘Is Smart Beta Still Smart After Taxes?’) in 2013 which questioned the net effect of smart-beta investing which did not take account of tax and other leakages.
The paper also showed that consistent outperformance could be gained by investing, cost-effectively, in value, momentum, low volatility and quality factors. The actual free lunch, though, comes from managing the after-tax positions. Raewyn Williams thinks of after-tax management as a new form of alpha.
– Greg Bright