Even with the ongoing debate surrounding the term “smart beta,” exchange traded funds with the smart or strategic beta classification continue gaining traction among institutional investors and registered investment advisors.
As of late August, assets under managements across smart beta ETFs totaled $350 billion, a 30% year-over-year increase. Much of that growth has been driven by institutional investors, including large money managers, endowments and pensions. The of these non-traditional ETFs has been exponential as smart beta ETFs accounted for just 19% of total industry assets at the end of last year.
“Low volatility, high dividend, and fundamentally-weighted ETFs are poised to see the greatest growth over the next three years as two-thirds indicate they are likely to use these products,” according to a research paper entitled “The Evolution of Smart Beta ETFs” released by Cogent Research and PowerShares earlier this year. [Bright Future for Smart Beta ETFs]
How investment professionals define smart and strategic beta ETFs is also important. Twenty-nine percent view smart beta ETFs as those funds that not cap-weighted, according to data posted by ValueWalk.
That means equal-weight ETFs, such as the popular Guggenheim S&P 500 Equal Weight ETF (NYSEArca: RSP) and Guggenheim’s suite of equal-weight sector ETFs can be considered smart beta funds, an assessment some industry participants agree with. [Strategic Thinking With Smart Beta ETFs]
Twenty-four percent of investment professionals define smart beta ETFs as funds that execute decisions based on a predetermined set of rules. Funds in this genre include First Trusts’s expansive line of AlphaDex ETFs that are based “on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets,” according to the issuer. That lineup includes well-known ETFs such as the First Trust Consumer Staples AlphaDEX Fund (NYSEArca: FXG) and the First Trust Health Care AlphaDEX Fund (NYSEArca: FXH). [AlphaDex ETFs Drive First Trust’s Growth]
Additionally, PowerShares, the fourth-largest U.S. ETF issuer, has one of the largest and oldest lineups of smart beta ETFs. For example, PowerShares issues nine sector ETFs that track relative strength-based indices from Dorsey Wright.
PowerShares transitioned ETFs such as the PowerShares DWA Healthcare Momentum Portfolio (NYSEArca: PTH) and the PowerShares DWA Industrials Momentum Portfolio (NYSEArca: PRN), among others, to those indices earlier this year and the changes have helped drive increased performance and inflows. [Index Changes Help PowerShares Sector ETFs]
Other PowerShares, including the PowerShares Dynamic Pharmaceuticals Portfolio (NYSEArca: PJP), take different approaches to strategic beta.
PJP, one of this year’s top-performing sector ETFs, and other PowerShares industry ETFs track indiceswhich evaluate companies for inclusion based on “price momentum, earnings momentum, quality, management action, and value,” according to PowerShares. [A Fabulous Pharma ETF]
Due to their factor-based styles, some smart-beta ETFs tend to generate out-performance, come with lower fees and diminish volatility. However, institutional players point to some drawbacks, including under-performance due to market timing, increased time spent on due diligence, lack of long-term track records and difficulty in comparing performance to traditional benchmarks.
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 with two-thirds of advisors surveyed saying they believe smart beta ETFs can help damp volatility and boost performance. [Big Investors Embrace Smart Beta ETFs]
Despite the debate over what to call these ETFs, what cannot be assailed is their increasing prominence in the ETF universe. Institutional investors are increasing their adoption of alternatively weighted or factor-based exchange traded funds, according to a survey released by Russell Investment’s in April.
The survey, entitled Smart Beta: A Deeper Look at Asset Owner Perceptions, indicated institutional investors with more than $100 billion in assets, 88% “have evaluated smart beta or plan to do so in the next 18 months; 77% of respondents with assets between $1 billion and $10 billion, and 50% of those with assets under $1 billion responded similarly,” said Russell.
