A DIFFERENT GAME
As in the broader smart beta community, there is a host of different labels ranging from strategic beta to alternative indexation. However, the most popular and preferred moniker seems to be smart beta. The tally at the end of August stood at 1,279, with 2,171 listings from 158 providers on 40 exchanges in 33 countries. Again the US dominated, with around 88.7% of smart beta assets invested in 631 ETFs/ETPs domiciled and listed in the country while 76.2% were slotted into 507 ETFs/ ETPs that provide smart beta exposure to the US market.
“The growth is a combination of factors,” says Chris Mellor, a product specialist at Invesco PowerShares. “We live in a relatively low interest rate environment where in many markets it is zero and there is also a greater focus on cost. It is a move away from pure active management but offers exposure to what managers have been doing in terms of smart beta but a lower price. Although there is a lot of debate about the definitions, most agree at the broadest level smart beta is a rules based systematic approach that deviates away from the market cap benchmarks.
BMO Global Asset Management’s head of product management, Canada, Mark Raes, also believes that the growth of smart beta ETFs reflects investor interest in sourcing differentiated exposures for their portfolios. “Smart beta strategies allow investors to differentiate the risk levels in their portfolios where adding factors like quality and income can result in low volatility portfolios,” he adds.
Performance and fees are also key contributing factors, according to Howie Li, CEO, Canvas, ETF Securities. “For some investors that are new to passive, market cap investing can have some unexpected outcomes because they are generally overweight the largest companies,” he adds.” The momentum increases as more investors allocate into the same investment to drive up prices but the downside can result in a sharp correction where there is herding.”
He notes that there is also pressure for asset managers to supplement their traditional market cap business (or their traditional active business model) in order to attract new/maintain business. “We’re seeing product providers codify what active managers have done for a while in a transparent and consistent structure that’s designed to add value to traditional market cap investing at a reasonable cost,” he says Li points out that most European ETFs are currently in the equity space, accounting for more than 65% of all European ETF products. Fixed income is growing at a much slower space and currently comprises only 25% of total European ETFs, likely due to the sophistication of the asset class with many more data points than equities.
The first wave of smart beta ETFs have been in the classic single strategies such as value, momentum, size, quality and low volatility as well as high dividend strategies which are often classified as a strategic ETF. They now account for 39% of total strategic-beta ETP due to the confluence of ultra-low interest rate environment and a growing base of yield-hungry investors.
“Although dividends are not typical smart beta products, the definition has widened to include other non-market cap strategies,” says Martin Weithofer, head of smart beta at Deutsche Asset Management. “Dividend indexes also have almost 10-year track records, but they do not always deliver the intended risk-return characteristics.”
Dividend strategies like many outperform the broader market over time, but there are concerns that these strategies may have become overvalued in today’s low-yield environment. The best performing factor has been value which although it shows some susceptibility to illiquidity, it along with the other styles, produced positive sharpe ratios regardless of the macro-economics over the long term, according research by AQR Capital.
While single factor ETFs are still fashionable, there is a move to multi-factor smart beta ranges to smooth out the returns. The first batch followed an equal weighting style but research from Morningstar shows that portfolio construction has moved to a ‘core-satellite’ framework, where one of the factors acts as the core building block and the rest – whether just one or a combination of several – address the potential downsides of its cyclical nature.
The best example is quality-dividend indices which favours the more profitable and less indebted, companies because they are likely to generate a less volatile income stream over the long term.
Low volatility is also popular as a core building block complemented by quality, value and/or momentum.
CHANGING TIMES
“The investor base is growing in sophistication and looking for more outcome oriented strategies to enhance performance and reduce risks,” says Sperandeo. “Multi-factor smart beta products are the second largest category after dividends in terms of ETF inflows this year globally and we see this trend continuing to grow as investors look to combine factors to achieve more targeted outcomes.”
Weithofer adds that “we are seeing the first signs of the industry reshaping its offering and trying to distinguish itself from other wealth management channels,” says.
“There are opportunities in multi factor ETFs and the industry has been analysing the best ways to combine and implement the factors.”The fee structures are also changing despite these products being more complicated than their commoditised plain vanilla counterparts. Goldman Sachs Asset Management fired the first salvo in September with its plans for its new equally weighted large cap equity ETF with a 9bps management fee. This is well below, for example, the similar Guggenheim S&P 500 Equal Weight ETF, which goes for 0.2%.
According to Stephen Tu, vice president, senior analyst at Moody’s, smart beta products will continue to attract assets at a fast pace, but the vast majority may not be able to command a meaningful premium over vanilla index products.
To date, most smart beta products have been priced between 24bps and 39bps, which is about half of the price of the traditional actively managed equity mutual fund of 63bps. In Europe, Deloitte said that the average expense ratio for ETF strategies is 31bps with the cheapest products tracking fixed income coming in at 26bps. There are also several ETFs though with a total expense ratio of less than 10bps.
