Smart beta ETFs are a rapidly growing segment of the fund investment market, and according to BlackRock Inc. (NYSE: BLK), one of the major providers of ETFs, that trend will not only continue but also accelerate into the mid-2020s. BlackRock is projecting what translates to an annual organic growth rate in the smart beta ETF category of roughly 20% per year through the year 2025.

The rise of smart beta ETFs, a relatively new type of ETF first introduced in 2003, has been a rapid one. In 2015, there was slightly over $30 billion in new investor capital inflow to smart beta ETFs, a record level. The first quarter of 2016 also saw record inflows to smart beta funds. BlackRock, with its well-known iShares funds, has been one of the major drivers of the popularity of ETFs overall, and particularly of smart beta ETFs. As of May 2016, two BlackRock funds, the iShares Russell 1000 Growth ETF (NYSEARCA: IWF) and the iShares Russell 1000 Value ETF (NYSEARCA: IWD), head the list of smart beta ETFs in terms of total assets under management (AUM).

Smart Beta ETFs

Smart beta ETFs are essentially passive, following a benchmark index, such as the Standard & Poor's 500 (S&P 500), but with a twist. Smart beta ETFs become quasi-active funds through adding a series of filters or screens, often referred to as factors, to the underlying index with the hope of achieving a portfolio selection that offers higher returns and better risk-adjusted performance. Common smart beta filters include volatility, momentum, dividend yield and earnings growth.

One of the notable characteristics of smart beta ETFs is that the more actively managed aspect of these funds means generally higher expense ratios, and it is an ongoing debate as to whether the higher expense is justified. However, there are plenty of smart beta ETFs with expense ratios substantially lower than the 2015 average equity mutual fund expense ratio of 0.70%. The top two iShares smart beta ETFs charge expense ratios of just 0.20% and 0.21%.

BlackRock and Smart Beta ETF Growth

BlackRock projects that total AUM in smart beta ETFs will grow from its early 2016 level of $282 billion to $1 trillion, essentially a fourfold increase, by 2020, and then more than double from there, reaching $2.4 trillion by 2025. If it plays out that way, this means smart beta ETFs increasing at double the rate of ETFs overall. The company sees smart beta ETFs that use volatility as a screening factor, one of the most popular smart beta strategies in 2015, continuing to be popular and one of the major drivers in the creation of new smart beta funds.

BlackRock figures to be one of the major beneficiaries of smart beta ETF growth. As the largest single provider of smart beta ETFs worldwide, iShares has nearly $70 billion under management in its smart beta ETF offerings, which number around 100 funds and growing. The iShares group of smart beta ETFs expanded in May 2016, with the introduction of nine new funds. The iShares multifactor market sector ETFs apply smart beta strategies to ETFs focused on various market sectors, such as financials and energy.

The company is pushing hard to more firmly establish itself as the smart beta leader in the ETF market. In addition to introducing the new iShares sector ETFs, Martin Small, the head of BlackRock's U.S. iShares business, stated that the company is introducing products aimed at providing investors with educational and research information on smart beta ETFs. These smart beta sector ETFs are part of iShares Edge, a newly created division of iShares funds that offers a collection of smart beta ETFs for investors to consider. In addition, BlackRock has produced an iShares smart beta educational guide, and launched the BlackRock.com/factors website as an online resource to provide investors with educational content on smart beta ETFs and a variety of analytical tools utilized in smart beta investing strategies.

BlackRock has been a major beneficiary of the boom in smart beta ETFs already. Between 2009 and 2014, it enjoyed a compound annual growth rate (CAGR) of 18.7%. If its projections for the smart beta ETF market prove correct, it may well do even better than that in the near future.

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