- In a study of 51 large institutional investors responsible for $800 billion, 30% of respondents said they are already using alternative indexes.
- Alternative indexes appeal to many because they allow investors to access market returns by capturing exposure to specific factors, such as value, quality and volatility.
- In a process termed the new active decision in beta management, asset owners determine the allocation of their total portfolio across a spectrum, creating an overall strategic portfolio to meet objectives.
Institutional investors are increasingly considering a continuum of options, particularly across the equity spectrum, and expanding their focus beyond simply passive or active strategies, a Northern Trust investor survey finds.
The first-quarter 2013 study, “The New Active Decision in Beta Management: An Analysis of the Role of Alternative Indexing,” found growing interest in the blurred area between traditional market cap-weighted indexing and active management. More specifically, the study, which examined the views of 51 large/sophisticated institutional investors from across the globe with a collective responsibility of more than US$800 billion, revealed that 30% of respondents are already using alternative indexes. Moreover, of those investors currently not using alternative indexes, more than 50% are considering allocating to these indexes in the future.
“Philosophically, we see alternative indexing as an alternative to active management,” said one of the study participants, a chief investment strategist at a large national pension fund in the Nordics. “When it comes to the question of alternative indexing replacing the role of active management, we believe it will to a certain extent. Not the role of a skilled manager capable of adding value, but replacing the less-skilled active manager who takes the market cap-weighted portfolio and tilts it in the same direction as the alternative indexes.”
Asset owners now must determine the allocation of their total portfolio across a spectrum that stretches across traditional beta, alternative indexes and engineered beta, and traditional alpha strategies, thus creating an overall strategic portfolio to meet objectives. This process has been termed the new active decision in beta management by Northern Trust because it requires great understanding of the investor’s goals, clarity around risk and due diligence similar to that undertaken for an active investment allocation. The decision is active, the investment is passive.
Alternative indexes are appealing to many because they allow investors to access market returns by capturing exposure to specific factors, such as value, quality and volatility. The choice to invest in such indexes hinges on the belief that these factors not only exist – but they are the factors driving market return now and in the future.
Whilst alternative indexes offer the possibility of lowering costs for such factor exposure, when compared to active mandates and the potential to improve performance compared to a traditional market cap-weighted index investment, the majority of investors are using these indexes to reduce risk and improve diversification. What factors attract the greatest investor focus? Value and low volatility, with 64.3% and 50%, respectively, of survey participants indicating their alternative index allocation aims to capture these factors and their associated risk mitigation benefits.
For more on the role of alternative indexes in portfolio construction, download the “The New Active Decision in Beta Management: An Analysis of the Role of Alternative Indexing” paper.