Amid another year of record asset growth for exchange traded funds (ETFs) in 2017, analysts are expecting more of the same in 2018 and that includes forecasts for continued growth for smart beta products. Through the first nine months of 2017, combined assets under management for smart beta ETFs listed around the world jumped nearly 22% to $644 billion.
Some market observers expect U.S. stocks will offer lower returns next year compared to 2017 and that equity market volatility could finally increase, prompting investors to consider fundamentally-weighted strategies as avenues for mitigating volatility or potentially bolstering returns.
“While much of the new money pouring into equity ETFs in 2017 has been to the broad, market-cap weighted U.S. and international products, smart-beta ETFs will likely gain in popularity in 2018,” said CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth. “CFRA expects a lower total return for the S&P 500 index in 2018 than what is likely to be achieved in 2017 and, as such, investors will either look for some downside protection or potentially stronger-than-benchmark returns.”
As CFRA notes, two smart beta ETFs that were popular with investors in November were the iShares Edge MSCI USA Minimum Volatility ETF (USMV) and iShares Edge MSCI USA Momentum (MTUM). USMV is the largest low volatility ETF trading in the U.S. The $15.1 billion USMV, which tracks the MSCI USA Minimum Volatility (USD) Index, is up 19.6% year-to-date.
USMV holds over 200 stocks and, perhaps surprisingly, the ETF devotes nearly 20% of its weight to the technology sector. The ETF's defensive positioning is evident through an almost 30% combined weight to healthcare and consumer staples names.
Momentum is one of the best-performing individual investment factors this year, easily outpacing low volatility and value as highlighted by a year-to-date gain of almost 38% for MTUM. MTUM follows the MSCI USA Momentum Index and allocates almost 38% of its lineup to tech stocks. Momentum ETFs are typically heavy on tech and consumer discretionary names. The consumer discretionary sector is 8% of MTUM's weight.
“The MSCI index behind MTUM does not have any sector constraints and is based on risk-adjusted performance over the past six and 12 months,” said Rosenbluth. “As such, technology stocks with strong momentum traits, such MasterCard (MA), PayPal Holdings (PYPL) and Visa (V) all joined MTUM with sizable weightings.”
With 2018 potentially bringing a new set of challenges, investors need to evaluate smart beta ETFs more thoroughly and consider the nuances between these funds.
“Whether a more risk-off or a risk-on approach is preferred is up to each investor, but CFRA sees smart-beta products gaining traction,” adds Rosenbluth. “Yet, understanding an ETF's performance record or its ability to replicate a unique index does not help investors determine what will happen in 2018.”