On the recent webcast (available on demand for CE Credit), Smart Beta—Here’s Where You Can Put It…, Rolf Agather, Managing Director of North America Research at FTSE Russell, explained that more and more investors are becoming aware of smart beta strategies and are incorporating them in a diversified portfolio. The percentage of asset owners reporting that they have not evaluated smart beta has significantly dropped to 12% in 2016 from 40% in 2014. Moreover, adoption rates have increased, especially in Europe this year.
Institutional investors are becoming a big driver of smart beta adoption. In 2017, asset owners with $1 billion to $10 billion in assets under management led smart beta adoption, with about 57% of such investors using smart beta. Adoption among the largest asset owners remain near 45% to 50% over the past three years.
When evaluating a smart beta strategy, asset owners pointed to risk reduction as the greatest reason for investing in these ETFs, followed by return enhancement, improve diversification, cost savings, specific factor exposure and income generation.
Many smart beta investors are mainly utilizing the strategies as a strategic or long-term investment, with the minority using smart beta ETFs as short-term, tactical allocations.
Most smart beta ETF investors have allocated toward multi-factor combination strategies that combine various market factors into a diversified portfolio. Agather pointed out that 74% of asset owners are currently evaluating multi-factor combination strategies. Nevertheless, many still look to single factor picks that focus on low volatility, value, fundamental weights, high quality and momentum, among others.
“We expect growth in smart beta to continue at a robust pace, as the adoption expectations of asset owners who are currently evaluating initial or additional smart beta allocations remains strong and satisfaction with smart beta among current users remains high,” Agather said.
When evaluating these smart beta strategies, Robert Bush, ETF Strategist for Deutsche Asset Management, explained that an investor would find a smart beta does a good job if positive alpha when considering the portfolio’s beta and return relative to benchmark market returns. For instance, Bush pointed out that the FTSE Russell Comprehensive Factor Index has exhibited a high frequency of monthly alpha generation over the benchmark Russell 1000 in over 15 years of historical data.
Abby Woodham, ETF Strategist for Deutsche Asset Management, argued that as investors make investments using a smart beta strategy, investors should think about some additional considerations before making the jump, such as the investment’s historical net fee returns, appropriate benchmark, statistically significant estimated alpha, costs to achieve the alpha, excess return and risk.
Furthermore, Woodham argued that some smart beta factors may do better than others during specific market conditions. For instance, when looking across a normal market cycle, the factors including value momentum and low size may outperform during periods of positive economic growth or booms and pro-cyclical recoveries. However, quality and low volatility shine during periods of market slowdowns and recessions.
“Market moves are hard to predict. Since individual factor upswings may be hard to time, we believe combining factors can help investors weather a variety of economic environments,” Woodham said.
Alternatively, investors may consider a multi-factor approach that helps keep a long-term, strategic portfolio diversified across various market conditions.
“Investors may help diversify their portfolios by shifting from industry and country diversification to factor diversification,” George Rector, ETF Consultant for Deutsche Asset Management, said. “Individual factors often maintain low correlations with one another, potentially lowering overall volatility when combined.”
For instance, investors may consider the Deutsche X-trackers Russell 1000 Comprehensive Factor ETF (NYSEArca: DEUS), Deutsche X-trackers Russell 2000 Comprehensive Factor ETF (NYSEArca: DESC), Deutsche X-trackers FTSE Developed ex US Comprehensive Factor ETF (NYSEArca: DEEF) and Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG), which combine five single factors into a multi-factor strategy, including value, size, momentum, low volatility and quality.
“Factors are like the nutritional components of a stock, characteristics that explain a stock’s risk and return. Blended together properly, these factors can potentially make a significant contribution to outperforming traditional market-capitalization weighted benchmark indices,” Rector said.
Financial advisors who are interested in learning more about smart beta investments can watch the webcast here on demand.