The Smart Beta ETF Segment Is Maturing | ETF Trends

Smart beta ETF strategies that incorporate factor-based investment styles to diminish risks and maintain upside potential have enjoyed a boom in recent years, but the growth spurt is beginning to level out.

Morningstar analyst Ben Johnson argued that the initial breakout momentum behind smart beta ETFs is starting to wane as new products come to market at a slower pace and pressure on fees rises, CNBC reports.

“The waterfront has been covered. More and more managers are looking to differentiate on price and fewer and fewer new entrants are making their way to the market,” Johnson told CNBC. “I think we’re seeing maturity in this space.”

Strategic beta, smart beta, enhanced ETFs or however you want to call the alternative index ETFs cover a range of strategies that aim to maximize investment returns and diminish downside risk as much as possible through customized indexing methodologies reminiscent of active management styles. These smart beta ETFs typically include factor based screens that look for companies that exhibit specific historically beneficial characteristics, such as low volatility, quality, value, momentum and size among others.

The alternative index-based ETFs exploded in popularity from 2000 and 2018. During that period, assets under management surged to nearly $800 billion from less than $10 billion, according to Morningstar data. Meanwhile, the smart beta ETF market share also rose to around 20% for all exchange-traded products.

However, the trends reveal that assets under smart beta ETFs are stabilizing. Moreover, since 2015, the number of new launches dipped to 59 in 2018 from 85 in the year before.

Johnson argued that the increasing pressure to cut fees could be one of the reasons keeping money managers from launching new new strategic beta products. Asset managers have been engaging in a fee war in the ETF industry, rapidly slashing costs a range of funds as investors grow savvy over the high fee levels.

“Anecdotally, [managers]don’t feel like fighting over fees. They have valuable ideas, they have valuable IP, but they don’t want to sell it for next to nothing,” Johnson said.

Nevertheless, Johnson believed ESG or investments that cover environmental, social and governance may still have room to run.

“All the things that fall into the ESG bucket certainly have begun to get traction,” Johnson said, highlighting the launch of an ESG exchange-traded fund earlier this year. But “I think further adoption is probably further out. Ultimately, that will be facilitated by being able to create a sort of holistic ESG-oriented portfolio.”

For more information on alternative index-based strategies, visit our smart beta category.