There are many ways to invest and all of them might work, as long as you have a clear understanding of your objectives and don’t chop and change every few years, according to Bob Maynard, Chief Investment Officer at the Public Employee Retirement System of Idaho.
“I believe there are a hundred right ways to invest and the real question is: ‘What fits your particular situation, and your history and tradition best?’,” Maynard said in an interview with [i3] Insights.
“But whatever investment approach you take, you’ve got to be able to stick with it for a five-, 10-, 15-year period. It has been the history of our industry that anyone who has stuck to a certain approach…, we’ve basically made the same returns over 30, 40 years,” he says.
Although Maynard has been a renowned critic of smart beta and factor strategies, it is not so much the underlying theory that he is sceptical about, it is the implementation of these strategies that still needs to be fine-tuned, he argues.
“It is clear in academic research that there are a number of strategies that have shown academic promise. Many of those are called the smart betas,” he says.
“The problem though is that when you look at those, they are not as easy to harvest as the academic literature says they are. And they don’t occur each and every year; they can disappear for years at a time.
Small cap value is clearly one of the best demonstrated smart beta strategies, [but] it disappears for almost a decade at a time.
“Small cap value is clearly one of the best demonstrated smart beta strategies, [but] it disappears for almost a decade at a time. You may remember that at the end of 1990s, the death of value investing was being trumpeted around and it was going to be a brand new world.
“Well, that turned out to be false.
“And last year, the small cap [premium] disappeared entirely. The only thing worse than small cap over the last seven months has been emerging markets,” he says.
Maynard argued that to make smart beta strategies work you need to stick with it for a long time, even when it doesn’t do well for a few years.
This is harder than it sounds, he says.
“You’ve got to stick with it and you’ve got to be able to keep your investment committee on track, because I can guarantee you that any ‘smart beta strategy’ will go through two to three years of marked underperformance compared to a straight-out approach. You’ve got to be able to keep everybody on track throughout those [years].
“That is the issue: do you have commitment?
“We actually do have tilts in our portfolio that we’ve kept for a long period of time. So I’m not necessarily opposed to them,” he says.
One of our biggest problems now is with high-frequency trading. We are like a big tuna swimming between sashimi chefs: we get cut.
Other than the ability to stick with these strategies over long periods of time, Maynard is concerned about the transaction costs of rebalancing non-market capitalisation strategies, especially as high-frequency traders have been adding to these costs.
“The problem with moving away from cap-weighted is that you have to be very careful about transaction costs. The rebalancing costs become huge and almost all those strategies have to have a supplemental strategy of how often you rebalance,” he says.
“One of our biggest problems now is with high-frequency trading. We are like a big tuna swimming between sashimi chefs: we get cut. And we get thinly sliced each time, so you’ve got a whole bunch of secondary issue of: ‘How do you implement and how do you track what you are actually going to get.”
“So they’ve got to be proven for a while and there is no indication that over time they make a stunning difference,” he says.
Part of the move towards smart beta and factor strategies is the increasing granularity of equity as an asset class. Managers look for more and more ways to slice and dice this asset class and this has been amplified by the low return expectations of bonds.
Diversification always means you are saying sorry somewhere.
But Maynard said diversification into bonds should not be seen as a return decision.
“It is your Armageddon hedge; you never look to bonds for returns. If the world goes to hell in a handbasket, you’ve got to have something to replenish your equity orientated strategies.
“I’m often asked why we keep our TIPS (Treasury Inflation Protected Securities) allocations, well… if I’m happy with my bond portfolio, usually that means I’m not happy with my stocks portfolio.
“Diversification always means you are saying sorry somewhere.”
“[Bond allocations] did their job in 2008 and 2009, which were classic cases. It did serve its basic purpose, which is it got you through terrible times.”
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.