Hedge Fund Beta Exposure of Towers Watson Clients

From Hedge Fund Insight staff

In a recent paper Towers Watson provided an overview on the smart beta investment thesis and some of the more common and implementable strategies.  According to the consultants smart beta techniques are worthwhile pursuing in asset classes that have historically been expensive, difficult to access and/or illiquid in nature. The research paper considers its application in commodities, infrastructure, foreign currency, reinsurance markets and alternatives.

Smart beta can provide many of these desired exposures in a relatively simple, low cost, transparent and systematic manner. An example is in commodity exposure. There are logical reasons for investors to invest in commodities – as inflation hedges, and to produce positive returns at a different cyclical point than equities. Commodity exposure via indices can be flawed because of index construction issues and roll risk. The smart beta solution is to use an approach which actively rolls futures positions and that goes beyond the front month of the futures strip.

The paper states that “Within alternatives, interest has arisen partly from a realisation that some of the things that hedge funds do at great expense can be reproduced with simple, easily accessible strategies at a lower cost. Consequently, access to alternative betas with fundamentally different return drivers to traditional asset classes can potentially be achieved without hedge fund-like fees.”

The investment consultants continue to observe an increase in the number of institutional clients allocating to smart beta strategies as well as the diversity of smart beta strategies available. Globally 65 Towers Watson clients added new smart beta mandates to their portfolios in 2012, and TW clients have over $20bn invested in smart beta strategies.

Smart Beta Exposure for Towers Watson Clients (in USD billions)

source: Towers Watson, data as of  end 2012

The Towers Watson paper includes the above break down of smart beta mandates put out by their clients.  The $20bn of mandates includes $300m of “hedge fund” smart beta strategies. The paper does not disclose what these hedge fund strategies, but Towers Watson have kindly responded to some enquiries from HFI. Towers Watson does not try to replicate hedge fund returns per se. That is the HF strategies are not replication of hedge fund index returns resulting from principal component type analysis, and implemented in futures.

The hedge fund returns “refers to what you might call ‘alternative beta’ strategies – so things like momentum or carry strategies.” The clients of Towers Watson have been advised to use carry strategies in commodities, FX (within DM and within EM separately) and fixed income. As spokesperson for the firm admitted that “the strategies we use are not necessarily hedge fund strategies per se or do not figure heavily in hedge fund industry allocations. Similarly we would not replicate some of the hedge fund betas if can get them more cheaply elsewhere (e.g. equities). ”

Towers Watson had $26.8 billion in advisory and fiduciary hedge fund assets in the middle of 2013.  The firm has a substantial and growing commitment to hedge funds strategies as a whole. That figure puts the $300m in hedge fund smart beta mandates into proper commercial context.  It is de minimis compared to active alpha, and alternative alpha strategies implemented through single manager and fund of hedge fund allocations.