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Tomas Franzén, Chief Investment Strategist at AP2

AP2’s Stumble into Systematic Beta

Implementing Factor Tilts

Tomas Franzén, Chief Investment Strategist of the US$35 billion Swedish pension fund AP2, sits down with [i3] Insights to reflect on the fund’s first careful steps into systematic beta strategies and how his team can extend the concept to include more of the overall portfolio

Tomas Franzén has been using smart beta strategies before it was cool. In fact, before it was really invented. But he admits it wasn’t because he had some divine inspiration or other great foresight.

“To be honest, we kind of stumbled into it,” Franzén says in an interview with [i3] Insights.

“We did an ALM study and we were looking into our global equity portfolio, asking ourselves whether we should have a regional tilt? Should we have a specific, fixed allocation for the US, Europe, Japan, and so forth,” he says.

“We couldn’t really come up with an insight as to how we could optimise those things, but what we did see at the time was that there was a huge allocation to US stocks. Did we really want to have such a huge allocation? Not necessarily. So we applied a gross domestic product-weighted portfolio.

“Smart beta was not invented yet, so we didn’t really think about whether this was a factor tilt or any kind of tilt. We just said: ‘We would like to have a somewhat less concentrated portfolio, but something that is related to some kind of fundamentals’,” he said.

Swedish equities

At the same time, Franzén and his colleagues also reviewed their Swedish equity portfolio, because they felt the external fund managers AP2 was using at the time did not add much value.

“The problem we had there is that we had a lot of external managers and those external managers tended to hug the benchmark a bit too much,” he says.

“This was in the aftermath of the IT bubble and crash and we still had some companies, like Ericsson, which had a rather large allocation in the Swedish market.

“We really didn’t want [our managers] to think about that too much, so we said: ‘We will give you a reconstructed [index] of our own, an equal weighted index, and then we would like you to pick the stocks you’d really like’.

“We attempted to enhance the external management; it was a sort of alpha decision. After a while, those managers failed miserably, so those mandates were closed down. They didn’t add any value. But we saw that the index did something interesting, so we kept the index and started to replicate the index instead.”

“So yes, we stumbled into [smart beta] in a sense,” he says.

Stumble into it, he may have, but he certainly did not fall at the first hurdle.

AP2 currently manages two thirds of its equity portfolio through systematic beta strategies, while the equity portfolio itself is about 45 per cent of the fund.

That is over $10 billion in systematic equity strategies.

Franzén still uses the equal-weighted benchmark for his Swedish equity portfolio, although it only applies to a part of the portfolio. Yet, this could change in the future, he said.

“We have 10 per cent of the overall portfolio in Swedish equities and we have about 35 – 40 per cent in equal weighted. We are actually thinking about extending it to 100 per cent; we think there is a logical to having a higher allocation.”

Value tilts and emerging markets

In 2006, AP2 started using fundamental indexation in its developed market portfolio after speaking with Rob Arnott, founder of Research Affiliates and one of the key people behind the Fundamental Index concept.

“In 2005, when the fundamental indexation idea and Rob Arnott came along, quite early we had discussion with him and this fitted very well into our experience and our narrative. We thought: ‘Yes, it makes sense that a value tilt to your portfolio should also have a similar renaissance as the other things we did’.

Last year, the Swedish fund extended the fundamental index strategy to its emerging markets allocation, adding a value tilt to half of its allocation.

AP2 is now considering whether to add a third index tilt to the emerging markets allocation.

“What we are thinking about this year is maybe have some type of low volatility strategy in emerging markets as well,” he said.

Asked if the emerging markets are deep enough for such a granular approach, Franzén said the fund’s allocation would not be so large as to skew the markets.

“About 11 per cent of our overall portfolio is in emerging markets and so far we have split it evenly between market cap and value,” he said.

“We probably should split our emerging markets allocation in three different buckets. Today we have two and if we add a third we would just equal weight them, at least as a starting point.”

“So it comes down to about a third of US$3.5 billion, so that would be about US$1 billion plus. That should not be a huge problem,” he said.

Tomas Franzén, Chief Investment Strategist at the Swedish pension fund AP2, spoke at the [i3] Equities Roundtable in Sydney on 22 March 2016.

See the photo gallery for the Equities Roundtable here.


[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.