Smart beta exchange traded funds that follow rules-based indexing methodologies increasingly grown in popularity, and this ETF segment’s growth potential still has more room to run.
“We’ve done the research and it suggests there is large capacity potential in smart beta and factor strategies,” Andrew Ang, Head of Factor Investing Strategies for BlackRock, said in a research note. “We believe capacity could be at least hundreds of billions and, in many cases, trillions of dollars of assets — more than 100 or 1000 times more than what is invested in factor strategies today — for capacity to be reached. Factor strategies appear to have a wide highway ahead.”
To put this in perspective, there is currently 2,403 U.S.-listed exchange traded products with $3.067 trillion in assets under management, with 730 enhanced index-based ETFs with $607.7 billion in assets, according to XTF data. Over $18 billion has flowed into U.S.-listed smart beta ETFs in the first half of 2017 after $43 billion in inflows over 2016.
The rising demand for smart beta ETFs has caused some market observers to wonder if factor strategies have become a crowded trade, eroding their potential gains.
However, investors should understand that smart beta ETFs is a newcomer in overall financial industry. To better understand the size and scope of smart beta ETFs, investors should keep in mind that the S&P 500 index represented $19.2 trillion in market value as of the end of December 2016. Of the $8.7 trillion in assets indexed or benchmarked to the S&P 500, actively managed mutual funds made up $5.7 trillion, whereas U.S.-listed equity smart beta ETFs only made up $224 billion or less than 1.2% of the total market capitalization of the S&P 500.