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For professional clients only Demystifying Alternative Indexation
For professional clients only
Demystifying Alternative Indexation
2 Demystifying Alternative Indexation
For a long time, there have been just two ways of gaining access
to equity markets – either through active or passive investing.
Depending on the markets available, investment objectives and
personal circumstances, passive may seem better value in some
cases, while other situations call for active.
Selecting a wrong type of strategy would typically manifest
itself in poor performance. The biggest risk with choosing active
investing is that it may underperform its comparable benchmark
while charging relatively high fees. That said, some active
managers can add significant value (net of fees) when they
succeed in selecting future outperformers.
On the other hand, by faithfully sticking to its underlying index
passive investing (be it an Index Fund or an ETF) can be relied on
for delivering the performance of their respective index whatever
the market environment. Low fees are also an attractive factor for
many investors as passive strategies do not have the expense of
maintaining teams of equity analysts looking at future prospects
of single stocks.
However, investors are no longer limited by the choice between
these two different investment approaches. A third option, or a
third way of investing, has been gaining popularity. It combines
key features of both active and passive strategies, while keeping
fees relatively low.
Rather than weighing companies according to their capitalisation
(their size relative to the wider market), alternative indexation (or
‘Smart Beta’) strategies use alternative weighting schemes to
arrive at stock weights.
There are different types of alternative indexation strategies.
Some use factors such as value and volatility to weight stocks,
while others weigh companies according to their fundamentals.
Brief descriptions of different types of alternative indexation are
given in the following table.
Alternative Indexation Demystified
Alternative Indexation Explanation
Factor investingAll stocks within the index are weighted according to a factor
anomaly believed to generate outperformance in the long term.
Low-volatility investing
Focus on minimising risk while assuming that all stocks will
produce equal returns. Construction is based on stock’s volatility
profile and their correlation to each other.
Fundamental investingStocks are weighted based on measures unrelated to market
capitalisation, such as company fundamentals.
Demystifying Alternative Indexation 3
Investment strategies tracking these types of indices fall broadly
into three categories: factor-based, fundamental and low-volatility
investing.
Factor-based investing
In this instance, index construction is based on a number of
factors that determine its weighting to a particular sector or area
of the underlying market. Examples of such factors include value,
small-cap and momentum.
The concept of factor investing is not new. In active
management, stock selection is often seen to favour a particular
style depending on a stage in the market cycle. For example,
some investment styles are described as ‘value investing’,
while other are ‘growth-oriented’ and focus more on smaller
companies.
Low-volatility investing
This type of a portfolio aims to deliver returns with a smoother
performance pattern than the underlying market. It is typically
achieved either through an in-built bias towards low-volatility and
low-beta stocks or by using an optimisation process to achieve
a lower volatility by combining stocks in a portfolio with different
return profiles.
Fundamental investing
A fundamental index strategy weighs companies in proportion
to their economic size or other fundamentals unrelated to
price. The strategy is rebalanced systematically to these target
weights. Index weights vary gradually to reflect the evolution
of a company’s importance within the economy over time.
For example, the ‘economic value added’ measure looks at a
company’s contribution to gross national product. It provides
a reflection of the changing relationship between companies,
sectors and global markets over time.
HSBC’s approachHSBC’s Economic Scale Indices weigh stocks based on the
economic contribution they make to the global economy.
They cover both developed and emerging market companies
worldwide and seek to generate better risk-adjusted
performance compared to a traditional index over the long term.
The HSBC Economic Scale Indexation series consists of a total
of 26 indices (counting the different currencies available) and they
are available on a single-country, regional or global basis.
Alternative indexation should be seen as another option for
investors alongside active and conventional passive investing.
At HSBC, we believe that alternative indexation has good
potential to present clients with another source of stable and
attractive return. We will continue our work in this area, looking
to offer an effective and low cost investment solution.
ContactFor more information, please contact us:
Email: [email protected]
Telephone: +44 (0) 207 024 0435
Website: www.assetmanagement.hsbc.com/passive
Important InformationFor Professional Clients only and should not be distributed to or relied upon by Retail Clients.
The material contained herein is for information only and does not constitute investment advice or a recommendation to any reader of this material to buy or sell investments.
This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe to any investment.
Any views expressed were held at the time of preparation and are subject to change without notice. While any forecast, projection or target where provided is indicative only and not guaranteed in any way. HSBC Global Asset Management (UK) Limited accepts no liabilityfor any failure to meet such forecast, projection or target.
The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. Where overseas investments are held the rate of currency exchange may also cause the value of such investments to fluctuate. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Stock market investments should be viewed as a medium to long term investment and should be held for at least five years. Any performance information shown refers to the past and should not be seen as an indication of future returns. Some of the ETFs invest predominantly in one geographic area; therefore any decline in the economy of this area may affect the prices and value of the underlying assets.
To help improve our service and in the interests of security we may record and/or monitor your communication with us.HSBC Global Asset Management (UK) Limited provides information to Institutions, Professional Advisers and their clients on the investment products and services of the HSBC Group.
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