Analytic Investors, the quantitative firm acquired by Wells Fargo Asset Management last year, is developing some of the industry’s first long-short smart beta funds as part of a broader range of data-driven products it is launching following its tie-up with the bank-owned asset manager.
The product range also includes smart beta mutual funds that opened earlier this year.
Harin de Silva, president of Analytic, thinks that few long-short smart beta funds exist today because managers and investors often view shorting stocks as overly complicated, especially when part of the appeal of these funds is simplicity and rules.
“Shorting is seen as overly complex,” he says.
But de Silva, who thinks low-cost factor-based investing will ultimately cannibalize actively managed funds, says shorting is a fundamental part of investing and can be handled in a rules-based fund. He’s currently writing a paper on long-short smart beta for an academic journal.
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Although de Silva published an article on a new approach to smart beta — one without shorting — in the Journal of Portfolio Management before his firm was acquired by Wells Fargo, he says Analytic wouldn’t have been able to launch funds based on his thinking without a larger firm’s support. It’s a function of the current environment in asset management, he says.
Big investors and defined contribution plans, for example, are moving to asset managers’ multi-asset products, which custom mix investments, as a lower-fee alternative to using third-party consultants that add a layer of costs. As part of Wells Fargo, Analytic can leverage the multi-asset group as well as the bank-owned manager’s global distribution network, de Silva says.
“In the past people would hire boutique managers and then they would oversee them. But with the tremendous pressure on fees, it’s hard to have multiple parties in the mix,” he says.
Analytic is also building risk models that only use environmental, social, and governance factors as their inputs. De Silva explains that the firm has been using ESG factors as part of its process for about three years, because companies with poor governance scores tend to have higher-than-predicted risk. Analytic is using ESG data from MSCI as well as OWLshares, an index provider founded on sustainability.
Analytic, for example, will look at the average ESG scores of stocks in the MSCI World index, and then aim to design a portfolio with a lower score, but which still meets the investments’ objectives.
“We want to design a portfolio so the impact of poor ESG scores is lessened,” he says.
De Silva argues that a risk-based approach to ESG is better than screening out companies altogether, such as tobacco businesses. That’s because many companies with poor ESG scores tend to be mature and safer companies from an investment perspective.
“When you get rid of the bad ESG companies, you end up with an index that can be riskier,” he says.
Not surprisingly, the quant shop is developing services based on the part of ESG that it has been able to quantify.
“We’re focused on the risk aspect of ESG,” de Silva says. “Other people may want a feel-good aspect. But the benefit of a portfolio with a smaller carbon footprint is so hard to prove.”
