The name of professor Rober Shiller, an economist at Yale University and a 2013 Nobel laureate, carries a lot of weight in Japan, according to Balaji Thiruvengadasamy, director of equities at Barclays Capital. In March 2014, Shinko Asset Management launched Shinko Shiller CAPE US-Europe Equity Strategy Fund based on the methodology licensed from Barclays. “[Shiller] came and we had four seminars with the investors,” says Thiruvengadasamy. “It’s been pretty well received.” In October 2014, half a year after inception, the fund held 61.3 billion yen (US$568 million) assets under management.

Barclay’s long-term collaboration with Shiller, the author of several books on behavioural economics, including the 2003 “Irrational exuberance”, resulted in a creation of a set of indices based on cyclically-adjusted price-to-earnings (CAPE) ratio which Shiller developed in 1988 together with John Y Campbell, currently a professor of economics at Harvard University. The company manages four regional CAPE indices: US, Europe, Japan and Asia-Pacific. They encapsulate the concept of value investing, making it easy and inexpensive to incorporate in a variety of institutional and retail investment products.

Value investing has been around for a long time, traditionally a domain of active fund managers. As active management yields ground to passive strategies, investment dealers have been enhancing their passive products by replicating strategies used by active managers. This gave rise to the “smart beta” approach – strategies which sit between passive and active ends of the spectrum by automating some of the investment decisions that active managers make.

The Shinko Shiller CAPE fund is an example of a growing number of investments that combine the active and passive management style. Its US and EU passive components are actively balanced based on macro-economic indicators. The allocation has so far favoured the US, overweighting it 3:1 with respect to EU, according to Thiruvengadasamy.

Nixing value trap

The history of CAPE ratio reaches as far back as Graham and Dodd’s 1934 classic “Security analysis”. It is calculated by computing a 10-year average of inflation-adjusted earnings, and dividing this number into the current stock price. This approach allows to focus purely on measuring the company’s value, regardless of the stage of the business cycle which impacts the company’s earnings, thereby altering its PE ratio.

It has been shown that the value of the CAPE ratio is negatively correlated with subsequent long- and medium-term equity returns. Building on this, Shiller popularized the method as a way to measure value and to identify opportunities for value-based investing.

Barclays’ algorithm is designed to identify undervalued sectors in the respective region’s economy. Ten sectors are analyzed, their scores are normalized by the respective 20-year averages, and five with the lowest CAPE ratios are chosen. To minimize the risk of “value trap”, the algorithm ignores the sector with the highest negative momentum. It then allocates the fund’s assets to the four remaining sectors equally. The allocation is re-evaluated monthly.

Each Barclays CAPE index comes in two varieties: “focused value” offering full exposure to the market, modified by the value-investing approach, and “market neutral value” that isolates the value component by hedging for the performance of the underlying market

Simulated as far back as 2002, the US market-hedged index averaged 4.07% annual return with a Sharpe ratio of 0.93. Its European equivalent, simulated back to 2008, averaged 3.55% annual return with a Sharpe ratio of 0.80. The Asian indices, also simulated back to 2008, performed less well, returning 0.20% annually in Japan and 0.43% in Asia-Pacific.

Barclays uses GICS sectors as the basis for its Shiller CAPE index for all industry sectors in the US, except real estate, covered by an iShares Dow Jones index fund. MSCI sector indices are used for Europe, Japan and Asia-Pacific ex-Japan.

Creating the Shiller CAPE indices has given Barclays a basis for launching a variety of products in response to market demands. The company makes the investments available to partners via swaps on the indices, or issues investment products directly. It sold its first product based on the index, a 10-year exchange traded note (ETN) in October 2012 in the US market.

In 2014, the company launched a 10-year principal-protected note with an option on the Shiller CAPE index in Taiwan. “It gives you flexibility of not taking the downside risk, but being able to pay for that protection. It opens up new possibilities,” says Thiruvengadasamy. The company plans to launch a Shiller CAPE ETF in Europe and another product in South Korea.

The success of the Shiller CAPE index scheme, which won The Asset’s 2014 Triple A Award for Best Structured Equity Product, lies in skilful implementation of value investing at a low cost. (The cost of the US ETN is 45bp.) “The question is to compare what is the incremental benefit you get by going fully active, and whether that is useful for everyone to undertake,” explains Thiruvengadasamy. It is a very good, low-cost approximation for something that you do in an active way, he says. “That is the key selling point.”