Smart Beta Could Help Ease the Fed Rate Guessing Game

When interest rate policy decision comes around, it could always be an extremely volatile moment for a market with violent swings happening at a moment’s notice. Smart beta funds that incorporate passive and active strategies could help ease the volatility that could ensue, especially if the central bank delivers a message that isn’t easily digestible by the capital markets.

The central bank cut interest rates by 25 basis points, but the markets reacted with over a 300-point loss in the Dow Jones Industrial Average.

“It was a very confusing and muddled message, and I don’t think that Powell delivered clear direction for what the near-term path of additional Fed easing will be, and I think that’s why the market reacted negatively,” said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.

Meanwhile, global assets flowing into smart beta funds have more than doubled in the last five years from $485 billion to $1.1 trillion based on Morningstar research. Exchange-traded funds (ETFs) thus far in 2019 have received close to $120 billion of flows in the United States, 62% of those flows went to fixed income and of the equity flows, 75% went to smart beta.

According to David Mann, Head of Global ETF Capital Markets at Franklin Templeton, this latest influx of capital into smart beta can be traced to a shift in investor behavior and fund performance.

“I had predicted inflows into smart beta ETFs would reach $100 billion this year, and although we don’t seem to be at a pace to hit it, I think the percentage of equity assets flowing into smart beta is very impressive,” wrote Mann. “As to why this is happening, a couple possibilities come to mind. The first is that investors have acknowledged there are other index rules besides simply letting market price determine the weight of the stock. The second is that many of these smart beta funds have performed very well over the past few market cycles.

Smart beta funds can incorporate a number of strategies in order to achieve returns, including active and passive methodologies. Thus far, the growth of passive funds is outnumbering their active counterparts.

According to the latest Morningstar report for U.S. mutual fund and exchange-traded fund (ETF) fund flows, passive funds notched their best month year-to-date during the month of June with inflows of $69 billion across all category groups. The market share for passive funds now accounts for 40 percent compared to a year ago when it was 37.4 percent.

Not sure where to start when locating a smart beta exchange-traded fund (ETF)? Advisors and individual investors can peruse through a long list of funds to choose from.

For more trends in smart beta, visit our Smart Beta Channel.