Smart Beta ETFs Receiving Healthy Inflows | ETF Trends

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. However, advisors can do more to ensure that investors throw caution to the wind prior to investing in smart beta funds.

Research by smart beta pioneer Research Affiliates shows that smart beta fund performance is falling short in comparison to their advertised returns. The Research Affiliates analysis used Bloomberg performance data to simulate investor experience of smart beta funds between the years 2009 and 2018.

The simulation showed that funds categorized within Morningstar’s strategic beta classification generated less than their benchmarks. Research Affiliates found that:

  • Global value funds underperformed by 3.83 per cent and 4.48 per cent over 10 and five years respectively.
  • Funds targeting momentum registered 1.38 per cent and 3.42 per cent losses over the periods.
  • US multi-factor funds, which are frequently touted as a diversified way for investors to gain exposure to all factors, lost 1.92 per cent over 10 years and 2.55 per cent over five years.

Vitali Kalesnik, head of equity research at Research Affiliates, said the performance serves as a warning to investors that smart beta strategies should be approached with caution.

“In many cases, investors’ expectations about the magnitude of outperformance were somewhat exaggerated,” said Kalesnik. “Many investors flocking to (smart beta) were unprepared for the ride. “They did not realize that factors are prone to crashes and potential prolonged periods of underperformance.”

However, he also stated that smart beta strategies in and of themselves are flawed. Advisors need to do more to explain to investors the risks associated with these strategies and to temper investor expectations.

“This does not imply that the factor investing strategies are flawed by definition,” said Kalesnik. “It’s not trivial to understand the risk profiles of these strategies. When they are marketed to investors, very infrequently do you hear the salesperson talking about the risks involved.”

Smart Beta ETFs Receiving Healthy Inflows

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.

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