Over the last few years State Street Global Advisors (SSGA) has concentrated its efforts on diversifying its beta capabilities and expanding its product offering into the alpha space.
With more than $1750bn (€1336.4bn) in assets under management, SSGA’s portfolio now includes investments in index, active and enhanced equity, fixed income and exposure to absolute return strategies, real estate, private equity investments and currency.
Enjoying a privileged position within the US institutional asset management market, one of the firm’s strategic goals is to expand its non-North American presence. According to Richard Lacaille, SSGA’s European CIO, the European market offers huge opportunities for growth including the development of funded pension systems across Europe.
The company currently manages $356bn assets for European-based institutional clients. “We are targeting many different markets and in many cases, like in Denmark, we are going in there as an alpha provider,” says Mr Lacaille. In the Netherlands, for example, the company has moved from just providing indexation to clients to offering alpha products as well as liability-driven investment (LDI) strategies.
Mr Lacaille is responsible for all the investment activities undertaken at SSGA’s investment centres in London, Paris, Munich and Zurich. Since he joined the company back in 2000 he has seen the move towards alpha and beta separation accelerating and impacting on its investment strategies.
“Our long history has been that of a beta provider, offering good value solutions for clients who wanted indexation,” Mr Lacaille says. SSGA’s passive portfolio currently represents $866bn. “Beta is still very important but its definition has broadened quite a bit from equity and bond indexation to liability-matching and liability-driven strategies,” he comments.
Revamping beta
The revamping of the firm’s beta offering has been significant in the fixed income area driven by the demand for LDI strategies. He also points that beta is moving into the hedge fund space. “If you look at the fund of hedge funds universe, there is a lot of the specific return in hedge fund managers that cancels out and what you are left with is a set of market exposures, something similar to an index fund,” he explains. “There are some exposures which provide a lot of the returns hedge funds buyers are receiving. I think the next level of beta is moving into that area, providing those exposures to clients who just want a core exposure to a hedge fund asset class.”
The use of wealth-weighted or alternative indices in the equity market is another development within its beta proposition. “In summary, the beta business has evolved quite substantially from simply tracking the S&P500 to providing, on a low cost basis, exposures to other strategies that investors want.”
Some of these changes have required substantial investment both in people and systems to ensure the investment teams can, for instance, effectively manage the derivative-based products used in some LDI strategies. “These are new to many on the buy-side and you really need to understand all the issues around trading. Some of these markets are not particularly liquid and the pricing of assets is difficult because some swaps are complex to price,” he explains. “Understanding whether there is good value on those swaps is very important for an asset manager.”
A smooth machine
In other areas such as equities, structural changes within the organisation have been less profound. “There is some investment in research so we can understand if the exposures we are providing are good value and sustainable. But in terms of implementation not a great deal needs to be done because the machine works very smoothly.”
In the alpha space, Mr Lacaille says the product offering is now broad enough to compete with other providers present in the market place. “The performance track record is now quite long and clients which are just interested in alpha would tend to dispense with any preconceptions of a company and just think about what that company has been able to deliver,” he says. “It is not just one strategy that happens to work. It is many strategies that have worked.”
“We are very proud of our beta roots because they bring a number of characteristics that our clients value such as risk control, compliance and trading capabilities. When you have a scalable beta business those things are absolutely critical so when you are buying alpha from us you’ve got the knowledge that all the basics are completely bolted down.”
As clients ask for more alpha, asset managers need to think carefully about how they are going to provide it. “One option is to turn up risk so you end up with fewer and fewer holdings which means your skill levels need to be extremely high,” he says. “If you are only picking 30 stocks in Europe you’ve got to be certain about those stocks. There is quite a lot of risk involved because there may be a lot of information that is not available to you.” Also, he adds, with fair disclosure rules sweeping the US and Europe, it is becoming more difficult for a portfolio manager or an analyst to unearth substantial information about a particular company that is not already in the public domain.
“In our view, if clients want substantially more alpha, 4 or 5 per cent, simply asking the manager to turn up the risk and have fewer holdings is not the most efficient way of doing it,” he says.
With this in mind, and taking into account the opportunities in the long-short world, SSGA started offering 130/30 strategies to take advantage of insights on both undervalued and overvalued stocks. Mr Lacaille says that when running 130/30 strategies, managers do not throw any information away. “If you are a quantitative manager you tend to be quite good at finding the winning stocks and also the ones that are overvalued – the losers. The differentiating factor is how managers make use of that information”, he says. When those ‘losers’ are large companies, managers have the option of underweighting those stocks. “However, if you look at our European universe most companies have a relatively small weight on the index so the value added that you can achieve for your clients by underweighting those stocks is pretty limited,” he notes. “Frankly if a company has a five basis points weight in the index, even if I know with certainty that that company is going to go bust, all I can do is not to hold it. On the other hand, if I am allowed to take a short position in that security, my potential gains are very substantial and that’s what a 130/30 strategy allows you to do.”
The increasing demand for long-short strategies from institutional investors comes at a time when returns in the hedge fund industry are not as high as they used to be a decade ago. Mr Lacaille believes one of the reasons behind this is that market volatility has also been lower. “Even if you look at active equity long-only strategies, the dispersion of returns is much, much lower than it used to be.”
However, the number of institutional investors moving into the sector is growing and new ways of approaching the asset class are being developed. A good example of this is the application of core-satellite investment principles to hedge fund investments, similar to those used in the long-only world. The core would be a passive replication of a hedge fund index, with niche single strategies used as satellites. “That might be one way the industry developing, but it is difficult because clients need to have the governance budget and the understanding that would allow them to choose those satellites.” He adds, however, that this is a natural development of the sector, “and it’s also natural that people analyse this as an asset class and think how much is alpha and how much is beta and how do they want to pay for that package.”
Perfect combination
Combining alpha and beta strategies within a single portfolio has become the norm for institutional investors. As portfolios become more sophisticated and open up to alternative asset classes issues regarding risk management and return diversification become crucial. Equity investors benefited greatly from the strong market performance last year; however 2007 has so far managed to make investors nervous about risk and volatility once again, following last month’s sharp fall in Chinese equities. Mr Lacaille describes this as a “volatility storm” caused by increase levels of volatility coupled with increasing risk premiums for credit and equity. “History suggests that these storms last quite a while and it will take some time for markets to recover their composure and reach a new equilibrium in terms of expected risk premium,” he says.
“The economic data that has been coming out over the last couple of weeks has really not altered our view that the US will have a soft landing this year and not a hard landing,” he comments. “Jobs growth will be more subdued that it has been in the past but still strong enough to maintain consumer confidence and expenditure. So we do not see the collapse that some are forecasting.”
RICHARD LACAILLE: THE MAKING OF A CIO
2002: Becomes SSGA’s European CIO
2000: Joins SSGA as head of their London-based structured equities team
1996: Following NatWest’s acquisition of Gartmore, he becomes head of structured equities of the merged company
1987: Starts work with County NatWest Investment Management
1984: Joins management consulting firm C Squared
