Institutional investors are increasingly looking to customized beta strategies to meet fund objectives, according to research by Northern Trust.
The firm’s white paper, Customized Beta: Changing Perspectives on Passive Investing, says that the growing use of passive investing has lead to a blurring of traditionally held views on the separation of alpha and beta, as more choices exist for investors within the spectrum of beta.
The firm surveyed 121 institutions—predominantly pension funds—in North America, Europe and Asia on their attitudes and practices at a time when economic uncertainty has put all eyes on transparency and risk management.
Of those surveyed, 40% identified customized beta as being relevant to their current portfolios. More than half of respondents (51%) said they would be interested in exploring customized indices as a way of addressing their objectives; however, only 22% have evaluated customized beta approaches.
“Investors around the world are reframing their thinking about their funds’ objectives, with an overwhelming 84% from our survey saying that meeting their investment objective is more important than outperforming a benchmark,” said John Krieg, managing director, asset management, Europe, Middle East & Africa region, Northern Trust.
Worldwide, approximately one-third of all institutions surveyed say passive products make up more than 40% of their equity and fixed income assets today. In the next three years, approximately 40% of respondents said that more than 40% of their equity and fixed income assets will be in passive portfolios.
Despite this trend toward allocating to index strategies, only 29% said they consider their level of exposure concentration from existing indices when selecting a new index. For 63% of respondents, index selection occupies 10% or less of the time they devote to investment activities. By comparison, 82% of all respondents spend more than 10% of their time on manager selection.
“Even if you spend a good deal of time selecting your manager, you could still fail to meet your investment goals if you choose the wrong benchmark,” said Krieg. “As the role of index investments in institutional portfolios evolves, along with the spectrum of techniques available to help investors achieve the index exposure they want, there is a need for more education about, and analysis of, the implications of customized beta approaches.”
Those surveyed cited two primary benefits to a customized beta approach: enhanced risk/return trade-offs and increased diversification. Beyond these, institutional investors around the world reported additional, varying benefits:
- European respondents view customized beta strategies as having the potential to boost transparency, and an effective screening tool to meet socially responsible investing and environmental, social and governance investment objectives.
- Asian respondents see customized beta strategies as a possible tool to increase efficiencies within portfolios by eliminating methodology- and weighting-based biases from standard indices.
- North American respondents consider customized beta strategies as a means of gaining exposure to new markets.