As has been widely documented, exchange traded funds are experiencing exponential growth as investors leave high-fee, often under-performing actively managed mutual funds. The primary drivers of broader ETF industry growth include smart beta funds, or those products that use weighting schemes that extend beyond traditional market capitalization.

In recent years, the growth trajectory of smart beta ETFs has been stunning, a theme that is continuing in 2017. At the end of September, there were nearly 1,300 smart beta ETFs listed around the world with $644 billion in combined assets under management, according to ETF research provider ETFGI. That represents year-over-year growth of nearly 22%. (For more, see: A Guide to Smart Beta ETF Investing.)

The compound annual growth rate (CAGR) of a smart beta ETF over the past five years has been 31.3% compared to just under 19% for the ETF industry as a whole, according to ETFGI. Today, 22 of the 100 largest US-listed ETFs fit the bill as “smart beta.”

The U.S. is the world's dominant smart beta market as “88.7% of Smart Beta assets are invested in the 628 ETFs/ETPs that are domiciled and listed in the United States, and 76.8% of the assets are invested in the 511 ETFs/ETPs that provide Smart Beta exposure to the US market,” according to ETFGI.

Room for Growth

As of mid-October, roughly 200 ETFs have come to market this year in the U.S., and more than 80 of those new funds are smart beta.

Alternative weighting is finding its way to the fixed income space, too. For example, the JPMorgan Global Bond Opportunities ETF (JPGB) debuted in April. JPGB is an actively managed fund that moves beyond the traditional weighting schemes found in standard beta aggregate bond funds. JPGB “expands investment horizons beyond traditional fixed income sectors, dynamically adjusting asset allocation and duration as market conditions evolve,” according to JPMorgan Asset Management.

While many traditional beta bond ETFs are heavily allocated low-yielding sovereign debt, JPGB reduces correlations to U.S. Treasuries and boosts income by venturing into investment-grade corporate bonds, junk debt and emerging markets bonds, among other fixed income assets.

Further underscoring the momentum behind smart beta ETFs, more than 50 smart beta ETFs have launched in the U.S. since the start of the second quarter.

The Multi-Factor Frontier

Many of the most established smart beta ETFs fall into one of three categories 1) Equal-weight 2) Dividends or 3) Single factor. Examples of single-factor ETFs include those funds that are dedicated to growth or value stocks.

Issuers have met challenges associated with introducing smart beta products by branching out to multi-factor funds. As the name implies, multi-factor ETFs employ more than one investment factor in the weighting process.

The JPMorgan Diversified Return U.S. Equity ETF (JPUS) is an example of a broad market multi-factor fund. JPUS tracks an index that “sets its sector weightings on the basis of the inverse of each sector's historical volatility. This effectively spreads sector-specific risk more evenly. The index then populates each sector with those stocks that earn the highest composite scores based on measures of value, momentum, size, and low volatility. Stocks that score poorly on these measures are tossed out,” according to Morningstar.

Issuers are also minimizing costs associated with smart beta ETFs. In the case of JPUS, that fund has annual expense ratio of just 0.19%, or $19 on a $10,000 investment, which is barely more than half the category average for U.S. large-cap smart beta ETFs.

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