In the world of exchange traded funds (ETFs), products that eschew traditional market capitalization weighting schemes, also known as smart beta, are a significant driver of broader industry growth. However, knowing that smart beta ETFs are growing at a rate that easily eclipses that of the wider ETF industry is only part of the story.
How and why end users, including registered investment advisers (RIAs) and other professional investors, deploy smart beta is meaningful as well.
According to a new FTSE Russell survey, Smart beta: 2017 global survey findings from asset owners, “the trend of asset owners reporting an existing smart beta allocation has climbed to 46%, up from 36% last year.”
It is often said that smart beta strategies “blur the line between active and passive investing.” As smart beta becomes more mainstream, the lower fees offered by ETFs compared to actively managed mutual funds should push smart beta usage higher. The average fee on a large-cap U.S. equity smart beta fund is about a third of a percent per year, below what is found on the comparable actively managed fund.
“Smart beta indexes are widely accepted by asset owners as an appropriate basis of an investable product, with 77% agreeing,” according to FTSE Russell. “Roughly half of asset owners view smart beta indexes as an appropriate benchmark for an active strategy.”
Marveling At Multi-Factor Growth
Within the fast-growing smart beta, a new frontier of growth is multi-factor funds. The earliest iterations of smart beta funds were either equal-weight ETFs, which essentially skew toward the small size factor, or single-factor funds focusing on a specific investment factor such as growth, quality or value.
An issue end users inevitably encounter with single-factor ETFs is that one year's leading factors can become the following year's laggards. Said differently, timing individual factors is tricky business. That enhances the utility and viability of multi-factor ETFs.
“Multi-factor strategies have become the top smart beta equity strategy used and evaluated, while Value and Low Volatility are the most widely adopted and considered single factor index-based strategies,” according to FTSE Russell.
An example of a live multi-factor ETF is the JPMorgan Diversified Return Global Equity ETF (JPGE), which is up 20% year-to-date. JPGE “utilizes a rules-based approach that combines risk-based portfolio construction with multi-factor security selection based on value, size, momentum and low volatility factors,” according to JPMorgan Asset Management.
JPGE's multi-factor approach helps the ETF diversify geographic, sector-level and individual equity risk.
Other Smart Growth Avenues
Data suggest that larger asset owners are increasingly adopting smart beta strategies. In previous years, many of the asset managers embracing smart beta had less than $1 billion in assets under management. Today, professional investors in the $1 billion to $10 billion in AUM category and beyond are showing increasing interest in smart beta.
In addition to multi-factor products, another growth avenue for smart beta ETFs are environmental, social and governance (ESG) funds. That movement is about much more than morals and social views.
“Primary motivations for using a smart sustainability index-based strategy are investment-led rather than regulatory or social,” said FTSE Russell.