Investors have quickly adopted alternative index-based or smart-beta exchange traded funds, largely at the expense of actively managed funds, and the trend could continue.
Mark Makepeace, chief executive of the FTSE Group, points out that traditional market capitalization-weighted passive investments make up 30% of money invested in major equities markets, leaving active managers with 70%, and a growing number of investors are taking an interest in alternative, factor-based index funds, reports Steve Johnson for the Financial Times.
“Half of that [70 per cent] over time will probably move to a combination of factor and multifactor-based [passive]approaches,” Makepeace warned in the FT article, arguing that the shift could lead to devastating consequences for active managers.
The ETF industry is currently enjoying a proliferation and growing popularity of smart-beta ETFs that track factor-based indices, which utilize a combination of actively managed styles to select component stocks instead of weighting holdings based on the traditional market-cap methodology. For instance, many factor-based ETFs select and weight companies based on revenues, book value, dividends, momentum and volatility, among others.
Makepeace points out that the growing popularity has made smart-beta indexing “one of the fastest-growing areas” for FTSE.
For instance, PowerShares Invesco offers a suite of FTSE RAFI Fundamental Index ETFs that utilize Research Affiliates factor or fundamental components, including sales, cash flow, dividends and book value.
The PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), one of the largest and oldest smart-beta ETFs, has $4.6 billion in assets under management and gained an average annualized 15.3% over the past five years. PRF will be celebrating its 10th anniversary on December 19 this year.
On Monday, the London Stock Exchange Group (LSEG) said it has combined its FTSE and Russell indexing business into one unit known as FTSE Russell. [London Stock Exchange Combines FTSE, Russell Brands]
Russell has provided some of the most popular asset style indices that are arguably the prototypes to smart-beta indexing as we know it today. For instance, Russell Index ETFs include the $25.1 billion iShares Russell 2000 ETF (NYSEArca: IWM) and the $6 billion iShares Russell Midcap Value ETF (NYSEArca: IWS). [LSE May Only Want Russell’s Index Biz]
Moreover, the PowerShares Russell 1000 Equal Weight Portfolio (NYSEArca: EQAL), which equally weights sectors and stocks taken from the Russell 1000 Index, has shown its advantages. [Equal-Weight Russell 1000 ETF Continues Shining]
Makepeace contends that since a lot of money is already being managed in a factor-based style among active managers who charge exorbitant fees, investors may, instead, turn to cheaper factor-based index ETFs.
“If [active managers]are being judged against a factor-based index, a pension fund can see what they are paying for,” Makepeace added. “The active managers will have to show that the returns they are generating are worth the fees.”
There are 350 U.S.-listed enhanced index-based ETFs with an average 0.56% expense ratio, according to XTF data. [Business is Booming for Smart Beta ETFs]
For more information on the enhanced index ETF space, visit our smart beta category.
Max Chen contributed to this article.