Tobam, an asset manager based in Paris, thinks it has an answer to those unmanaged risks waiting to pounce on portfolios.
It’s advocating for more diversification, and not just a little more. Try twice as much.
“If you look at the traditional indices, market cap-weighted indices, you will typically find they are only capturing half of the available diversification,” Christophe Roehri, managing director for the firm, tells Advisor.ca. “In very large investment universes, it’s even worse.”
Market cap-based indexes are not well diversified, he says, the worst-diversified probably being Switzerland’s SPI.
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Yves Choueifaty, Tobam’s founder, chief executive, and former head of quantitative asset management for Lehman Brothers, is considered one of the founders of smart beta (though he dislikes the term because of its unclear terminology). He developed and patented a new measure for diversification, through which the firm is offering portfolios with “maximum diversification”—typically double that of the average cap-weighted index.
“We organize the portfolio in order to maximize the diversification ratio,” Roehri says, adding that the Tobam measure has become “widely used” by the industry. (Mackenzie Financial Corporation recently launched ETFs and mutual funds using the methodology, and says it’s the only Canadian firm currently offering them.)
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The premise: market cap indexes are not neutral, Roehri says. He argues they contain unmanaged risks and dynamic structural biases based on investor bets and outlooks.
Index concentrations change over time, he says, with the largest-cap companies carrying more weight. The indexes of the early 1980s had high concentrations of oil companies, while in the late 1990s it was the dot-coms, he says. Today it’s large IT companies like Apple Inc. and Google Inc.
“Passive portfolios, market-cap-rated portfolios, are not neutral,” Roehri says, taking direct aim at investors who pile into purely passive, market cap-weighted ETFs. “Very often, people confuse being neutral and being passive.”
Using its maximum diversification methodology, the 10-year-old company employs what it calls its Anti-Benchmark strategies, managing more than US$8 billion. Tobam says the strategies “capture the risk premium of an asset class without biases.”
This is because it’s focused on diversification as opposed to market cap. Market cap-weighted indexes, Tobam says, are really comprised of asset values and the sum of all bets by active managers.
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Choueifaty, the firm’s chief, has questioned the very logic behind active managers trying to beat market-cap weighted indexes, what he calls a false idea sowed by people selling index investing.
As he wrote in an op-ed in the Financial Times this year: If the benchmark is the average speed, shouldn’t active managers be trying to raise the average, as opposed to trying to beat it?
Where active managers and advocates of smart beta strategies might criticize passive index investing, those behind index funds point to their performance and low costs. Data from S&P Global this month showed that 85% of actively managed, large-cap funds underperformed the S&P 500 in the past year.
In truth, it’s not an either-or conversation. Different approaches to portfolio management can be very much complementary.
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Roehri, making his case, points to BlackBerry’s affect on markets when the company’s stock plummeted by 75% in 2011.
That year, Tobam’s Maximum Diversification Canada Index outperformed the MSCI Canada index by 6%, even while the Tobam index was weighted by double the amount of BlackBerry shares.
This was because the Canadian index contained assets correlated to BlackBerry, while the Tobam diversified index was made up of unrelated, “anti-BlackBerry” stock, he says. “The rest of the portfolio was particularly immune to what was happening to BlackBerry,” he says.