In the exchange traded fund industry, a growing number of money managers and new fund sponsors are turning to alternative or smart-beta indexing methodologies to gain an edge in an increasingly competitive market.
According to Mark Makepeace, who runs the FTSE Russell index group, smart beta strategies make up about 60% to 70% of requests for new products from clients, reports John Authers for the Financial Times.
A growing number of clients are turning to their index providers, capitalizing on the growing team of exerts in quantitative finance to develop strategies that eschew traditional market capitalization methodologies.
“Can I create an algorithm to be Warren Buffett? No,” Baer Pettit, head of index strategy at MSCI, said on Financial Times. “But over time, can I do a lot of what he does systematically? Maybe. You can at least avoid the same things that he avoided.”
According to Create-Research, a recent survey of international fund management found that smart beta makes up about $300 billion in assets, or 18% of assets in U.S.-listed equity ETFs, and many expect the number to grow.
Among the first to proliferate in the space, Research Affiliates, which was founded 10 years ago and developed the FTSE-RAFI index, has created a number of products based off standard market-cap FTSE indices but gave them a twist by selecting securities on other factors, such as sales, earnings and dividends.
Additionally, other popular smart-beta index-based ETFs screen component holdings based on factors like dividend yield, low volatility and momentum, or popular investment styles typically found in actively managed fund portfolios.
These smart beta indexing methodologies try to prove an alternative to market-cap-weighted indices. Critics argue that traditional passive indices tend to overweight overvalued stocks, or in bond indices, the most heavily indebted issuers, which may expose investors to undue risks.
Smart beta is “quite a healthy development, because it fractures and diversifies the investment community” and mitigates the natural human tendency to herd around the hottest stocks, George Cooper, author of The Origin of Financial Crises and a critic of index investing, said.
With a greater number of providers rushing into the space, fees charged for licensing indices, and for investors, are under downward pressure. Without a defined powerhouse enjoying a first-mover advantage, the smart-beta ETF space is still pretty much up for grabs.
“The pros are the third party and the brand. You pay a small fee, but the view was that you needed someone else’s imprimatur. Now, the market doesn’t care who draws it up,” Nick Smithie, head fo research at Emerging Global Advisors, told the FT.
There are now about 479 U.S.-listed enhanced index-based ETFs on the market, with $246.4 billion in assets under management, according to XTF data. The largest is the WisdomTree Europe Hedged Equity Fund (NYSEArca: HEDJ), which attracted over $15 billion in net inflows so far this year. HEDJ provides Eurozone exposure and hedges against a depreciating euro currency.
For more information on smart-beta funds, visit our smart beta category.
Max Chen contributed to this article.