Smart Beta: It’s Turning Up Everywhere
“Smart beta” or “factor-based” ETFs are turning up in more and more places. The strategies vary widely – from equally weighting stocks to identifying momentum in different corners of the bond market, to name a few – but, what makes them interesting to investors is the ability to add exposure to a factor or set of factors in a portfolio.
As with any investment strategy, understanding how it fits in a portfolio is vital. With smart beta, that means knowing the factor or factors that are optimized in an ETF’s underlying index, and understanding how an ETF built on these factors will interact with other elements in an investment strategy. Does an ETF built on bond market momentum replace or augment other fixed-income holdings? How will a low-volatility position impact overall returns across a market cycle?
Investors and advisors are looking closely at these questions, even as more and more smart beta strategies become available. Investor interest is certainly there. Last year, single- and multi-factor ETFs attracted more than $8 billion in assets globally, according to a recent story in Pensions & Investments.1 Total assets in these funds (including Exchange-Traded Products (ETPs)) hit nearly $560 billion globally by the end of February 2017, including nearly $500 billion in the U.S. alone, according to the research firm, ETFGI.2
ETFs like these are finding their way into more and more institutional portfolios. Roughly 65% of U.S. pension funds, including corporate pensions, public pensions, foundations, and endowments surveyed by Greenwich Associates, have already been buying and holding ETFs for two years or longer.3 The trend is just as pronounced overseas, particularly in Europe, where a growing number of institutions is adding exposure to factor-based ETFs.
Hedge funds, which have long used ETFs to express specific market or asset class views, are also getting on board with smart beta. At present, hundreds of hedge funds are holding smart beta ETFs in their portfolios, a number that is likely to grow.4
Today, there are hundreds of smart beta/factor-based strategies available to investors. Some represent relatively minor tweaks to existing broad-based indexes, while others are more narrowly tailored to capture return from a specific geography, investing style, or asset class. As with any innovation, a great deal of education will be needed to help all different types of investors understand just how these different factors function and which approaches might be appropriate for them.
But, this isn’t really about a handful of approaches being “best” or “right.” It’s about understanding what’s on offer and using the best available tools to find solutions and construct portfolios to meet investors’ goals. If the rapid rise of these funds is any indication, it’s clear that everyone from financial advisors to pension plan sponsors has found them to be useful. Advisors and their investors should take time to assess the role smart beta can play in their portfolios as well.
1. Source: Baker, Sophie, “Smart Beta ETFs Gaining Traction,” Pensions & Investments, 7/17/16.
2. Source: “ETFGI reports assets invested in smart beta equity ETFs/ETPs listed globally reached a new record high of 560 billion US dollars at the end of February 2017,” ETFGI press release, 3/22/17.
3. Source: “Institutional Investment in ETFs: Versatility fuels growth,” Refer to Greenwich Associates 2015 U.S. Exchange Funds Study, as seen in Greenwich Associates LLC, Q1 2016, p.7.
4. Source: ETF.com via FactSet, Murphy, Cinthia, “How investors are using smart-beta ETFs,” ETF Report, 6/17.
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Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices.
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