The new breed of smart-beta exchange traded fund has shaken up the industry, providing an alternative index-based strategy that takes advantage of market inefficiencies, and institutional investors are taking notice.
On the recent webcast, Why Institutions are Using Smart Beta ETFs, Invesco PowerShares ETF Institutional Consultant Robert Ross explains how smart-beta ETF strategies help investors garner more intelligent exposure to the markets instead of just relying on cap-weighted beta.
“PowerShares was founded on the basic idea of providing access to indexes that go beyond market cap weighting,” Ross said.
For instance, PowerShares was among the first to introduce dynamic market portfolios, such as the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), a broad U.S. market ETF that weights stocks based on fundamental factors like book value, cash flow, sales and dividends. PRF was launched in 2005. [Behind a Stellar Fundamental ETF]
Additionally, the company has since expanded its line of fundamentally weighted index-based ETFs. For example, its first international portfolios were launched in 2007, including the PowerShares FTSE RAFI Developed Markets ex-U.S. Portfolio (NYSEArca: PXF) and PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH).
As more investors turn to ETFs to capture broad market exposure, some are beginning to dabble in smart-beta ETFs as well. Institutional growth has particularly been a major driver in smart-beta adoption – non-market cap weighted ETFs, which represent 19% of overall ETF assets, attracted over 29% of U.S. equity ETF inflows over 2013.
“As pensions, endowments, foundations, and asset managers continue to prioritize transparency, liquidity, and ease of implementation, more and more institutional decision makers are using ETFs for both tactical and core allocations,” Ross added.
However, greater education is still required for the nascent smart-beta ETF space, according to Steven Sixt, Senior Director, Research and Consulting, Market Strategies International
“Overall awareness of the Smart Beta ETF category is still in its infancy as institutional decision makers admit they only first heard about these products in the last few years,” Sixt said.
For many decision makers, rules-based or smart-beta ETFs are considered “hybrid” investment assets. The ETFs combine traditional passive indexing methodologies with additional rules that mimic actively managed styles.
Due to their factor-based styles, these smart-beta ETFs tend to generate outperformance, come with lower fees and diminish volatility, Sixt added. However, institutional players point to some drawbacks, including underperformance due to market timing, increased time spent on due diligence, lack of long-term track records and difficulty in comparing performance to traditional benchmarks. [An Impressive High Quality ETF]
“The need to reduce portfolio volatility and access higher beta strategies are driving smart beta usage among institutional decision makers,” Sixt said.
In a recent ETF Trends survey, the majority of financial advisors indicated that they are investing in smart-beta ETFs to generate better risk-adjusted returns.
Financial advisors who are interested in learning more about smart-beta ETFs can listen to the webcast here on demand.
CORRECTION: Market Strategies International