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How Fidelity's Bateman blends beta and active

James Bateman, head of multi-manager at Fidelity Worldwide Investment, explains how smart beta is used alongside active management and bespoke commodity exposure

What type of smart beta products do you use?

There are two main parts to smart beta. One is rejecting traditional market cap-weighted indices for more efficient indexing, which is likely to outperform in risk-adjusted terms.

The other type is the creation of quasi-passive strategies that proxy certain factor exposures in a market, such as companies with low volatility, for example.

The first concept has been around for a while. Conventional, market cap-weighted indexation does not work in theory because the index is biased to those companies that have outperformed in the past.

But the more interesting side to smart beta is whether it is possible to proxy certain parts of an index through factors by segmenting the broad indices, such as the S&P 500, into sub-sectors, grouping high-growth or momentum stocks together, for example.

How do you play these ‘quasi-passive’ themes?

If you want a portfolio that can perform across all markets, you need managers who can perform consistently in their respective sectors. But if it happens that a manager in one bucket is not very good, smart beta can proxy a bucket with a passive strategy, or quasi-passive strategy, for a lower cost.

So rather than invest in a large-cap dividend-paying fund, we bought the SPDR S&P US Dividend Aristocrats ETF. This tracks companies that have grown their dividends over the past 25 years and increased their return on equity. I cannot find an equity manager who outperforms this index with the same style bias. Using the low-cost exchange-traded fund also frees up our budget.

We can therefore keep the smoothness of returns by combining multiple styles without having to always use active management.

There are buckets of stock types you want to own because that sort of stock is in favour and will outperform, but you can also get access to this with a low fee via passives.

One area we are looking at for smart beta is solid but unloved growing companies that can consistently deliver high single-digit returns. It is like a fund that should deliver no upside or downside surprises.

Do you use any vanilla ETFs or index trackers within your portfolios?

In the US we use an index tracker as a source of exposure because large caps are hard to outperform and it helps us manage liquidity.

We do not use ETFs as much because they are more expensive, although we use them with passive funds as a liquidity buffer. Index trackers are cheaper for us than ETFs because we place large deals.

In what ways do you use ETFs?

We use ETFs across most equity markets for liquidity reasons. We are quite a fan of iShares because they can provide the liquidity and this is the biggest risk when using ETFs as a liquidity buffer.

When there are inflows and money comes in, we put it into a regional ETF initially. We then move the majority of it into an index fund for lower costs over the longer term. We use ETFs to manage short-term cashflow because of the intraday liquidity they offer.

Do you use smart beta to gain exposure to commodities?

We use a custom-built exchange-traded commodity for active commodity exposure. We are able to decide the weights of the Dow Jones sub-indices in this product – it is custom-structured by an investment bank.

You do not want to have physical exposure in certain commodities such as agriculture. In these cases you need synthetic exposure, which is why we have opted for custom-built ETC across commodities.

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