Smart beta: the landscape is about to change big time

Andrew Francis and Mike Aked
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by Greg Bright

Over the next few months the challenge for the major smart beta providers in Australia and New Zealand will change dramatically. It’s not necessarily bad news for investors, though. But it’s not so good, either. The two biggest players in the market, who have been joined at the hip for years, are parting company next April.

Realindex Investments, the largest standalone smart-beta manager in the region with about A$28 billion under management, has built up its internal capabilities, including hiring its first head of investments, David Walsh, an experienced quant investor. That news is scheduled to be announced today (September 2).

Realindex is a wholly owned subsidiary of Colonial First State Global Asset Management (CFS GAM), which is now owned by Mitsubishi UFJ Trust and Banking Corporation, which has about A$800 billion under management in its funds management business, compared with about A$210 billion at CSF GAM. Both firms are global and CFS GAM will be allowed to operate autonomously, but its more western culture will give some of its business units, such as Realindex, greater opportunities to explore in the coming years, leveraging off Mitsubishi contacts and capabilities.

Until now, Andrew Francis, the Realindex chief executive, said that all of the firm’s clients had been Australian domiciled. “We have never tried to market our services offshore,” he said last week. “We know we can be of relevance to offshore clients, though… With regards to [Mitsubishi] I’m sure if there are new opportunities there, then we can see them.” Riding the crest of the smart-beta wave better than most, Realindex’s funds under management have just about tripled in the past three or four years.

CFS GAM’s important information partner with Realindex, which was launched in 2008, is also building up its resources and shifting its business model in Australia and New Zealand. Research Affiliates will now be “going direct” to fiduciary investors rather than relying solely on its ‘partners’.

The Californian-based Research Affiliates, arguably the most influential firm in the world in the smart-beta strategies space, set up an office in Melbourne in 2017, sending back home its experienced Australia-born research executive Mike Aked to put more time into growing the business in the region. Ahead of the split with CFS GAM, Aked has now hired Adam Willis to set up an office in Sydney. “Realindex wanted to have a more active relationship,” Aked said, “which we don’t really have anywhere else in the world.” Willis, also Australian born, most recently worked at Legal & General Investment management in the UK.

The other important partner for Research Affiliates in Australia and NZ is Parametric Investments, which has about $A23 billion of Research Affiliates-advised money being implemented globally. Parametric runs A$10 billion sourced from Australasia across a range of strategies, a small part of which is based on Research Affiliates information.

Chris Briant, the Australia country head for Parametric, said that what his firm could do, and not many others were able to, was to implement smart-beta and active strategies in a tax-efficient manner. “We’re implementation specialists,” he said. “We don’t make calls on the underlying investments. That’s up to our clients and their advisors. But we believe we will make their decisions happen in the most efficient manner possible on behalf of the investors.” Parametric has been working with Research Affiliates for about 10 years, the last eight in Australia.

Briant said: ““We have seen a spike in interest from Australian funds wanting to implement RAFI [Research Affiliates Fundamental Index] through us in a tax-effective and transaction cost-effective way since it became known Realindex and RAFI had decided to part ways.”

Both the Realindex story in Australia and the Research Affiliates story in California are worth recounting. Realindex was launched by Graham Hand, now the publisher of the influential investment newsletter Cuffelinks. He was a former company secretary of Colonial First State, working with its chief executive Chris Cuffe, and moved on to head up the CFS ‘alliances’ business, which included investments in 452 Capital and Acadian Australia.

“I was at Perpetual and got a call from Graham,” Francis said. “It was very attractive to be involved in a start-up like that. I thought it was a great opportunity, although Perpetual was a fantastic company to work for, so I had mixed emotions.”

Realindex has 13 staff, including David Walsh who starts today (September 1), of whom 10 are investment professionals.

The shift in focus for Research affiliates is just as significant. While Realindex never sought to licence a Research Affiliates index and always provided its own backoffice, the two largest quant managers in the world – BlackRock and State Street Global Advisors – operate, as Research Affiliates’ Mike Aked refers to the arrangement: “our trading desk”. Of course, and as you’d expect, BlackRock and SSGA do a lot more than that.

Started by Rob Arnott in leafy Newport Beach, California, in 2002, Research Affiliates took off as a business when it developed its famous RAFI (Research Affiliates Fundamental Index), which, if not the first smart-beta strategy, was certainly the best marketed. Arnott is still a frequent author of white papers and client notes. He has also become, in the great American tradition of successful businessmen, a generous philanthropist with his glamorous Russian-born socialite wife who oversees his foundation.

Aked said: “Our 16 years executing our unique business model has demonstrated that we can effectively deliver on the three channels, Product innovation and design, Research, and Marketing/client support.  For example, with respect to transaction costs alone, we’ve published several articles surveying the embedded transaction costs in over factor and smart beta approaches… Of course, transaction costs are only one element.  We’ve also thought carefully about direct licensing costs. We already noted our commitment and history to passing along the benefit of scale to our partners and end clients.  We also continually ask, “How can we deliver our insights and products most efficiently to clients?”  The 2017 launch of RAFI Indices, our own index company, is one recent noteworthy example.

“Unfortunately, it seems that this model is no longer aligned with the strategic direction of Realindex.  A partnership based on a-la-carte services is also not consistent with our mission statement, our business model, and is ultimately suboptimal for creating maximum investor impact. We believe that this basic misalignment is just one of the reasons we did not agree commercial terms with Realindex”.

He said: “We have valued our nearly 10 years of partnership with Realindex and CFS GAM. We are very proud of the joint success our firms have had in bringing the concept of smart beta or systematic rules-based strategies to the Australian investment community.”

For his part, Andrew Francis said that the future was bright for Realindex, and it represented a great opportunity under its new owners. But it’s not without risk. As he says: “We have run our own race for a long period of time, with good success.”

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