Adviser warns over smart-beta underperformance

Studies have shown returns for some low-volatility ETFs have not delivered against similar funds. Jessica Cutrera has urged investors to do their homework on smart-beta products.
Adviser warns over smart-beta underperformance

A Hong Kong advisory firm has warned investors to choose smart-beta ETFs carefully after a study found strong divergence in short-term performance of products with similar portfolio composition.

EXS Capital, a Hong Kong-based wealth management firm that uses ETFs extensively as core products for client portfolios, did some performance comparisons of smart-beta products and found  some had underperformed quite dramatically in the last year when compared with peers.

Jessica Cutrera

“We carried out an analysis on several smart-beta products that are supposed to be nearly identical," Jessica Cutrera, managing director at EXS Capital, told AsianInvestor.

Comparing low-volatility S&P500 ETFs, their numbers are markedly worse, especially when put up against minimum volatility ETF returns. The PKW 'Buyback Achievers' ETF from Invesco Powershares has a three-month return of -7.89%. This contrasts with the -2.48% posted by iShares MSCI USA Minimum Volatility ETF. Three-month performance of another smart-beta fund, the Guggenheim S&P 500 Equal Weight, is -6.96%. 

While all of the funds in the peer group are under water this year, the divergence of returns is notable. “It highlights the importance of choosing your smart-beta products carefully," stressed Cutrera.

“It’s been an interesting exercise for us, not just in looking at these smart-beta products, but more widely at, for example, US large cap. There’s still a lot divergence."

She urges investors to be aware of the potential pitfalls of moving away from mainstream ETFs. “For investors who aren’t going to take the time to do the due diligence, it’s really a blind-eyed look at the market," she noted. "You’d be better off with plain vanilla funds."

Cutrera is not suggesting investors be wary of all smart-beta funds. In fact, she says some have done well in protecting investors during equity market turmoil in July and August.

“Our analysis shows that minimum volatility ETFs have made a big difference in protecting investors, so there’s clearly a place for smart beta,” she said,

Although there are only a few smart-beta ETFs available locally, a July survey by Deutsche Bank indicated that smart-beta ETFs were high on investors’ wish-lists.

Asked what new products they would like to see, 12% chose smart-beta ETFs that select and weight securities based on factors such as minimum volatility and high dividend.

Deutsche’s vice-president of passive management for Asia Pacific, Anson Chow, said that while there had yet to be an explosion in growth of Asian-listed smart-beta ETFs, institutional demand was growing.

At this point, Asian institutions that have adopted some alternative indexing are doing so in a tentative manner. Pension funds such as Japan’s GPIF and Taiwan’s Bureau of Labor Funds adopted smart beta this year for a small percentage of their equity exposure, typically about 5%.

Chow’s colleague Marco Montanari, head of passive management at Deutsche Asset & Wealth Management, confirmed the client base for ETFs in Asia Pacific was still mainly institutional, but said the experience was different by country.

In Australia self-directed pension schemes and the increasing presence of IFA distribution is helping the diffusion of ETFs across retail investors. In Korea and Taiwan, and also in Japan, there is a strong presence of day-traders using leveraged and short ETFs. In Hong Kong, day-traders have been very active in China-related ETFs.

But it remains a fact that in Singapore, Hong Kong, Korea, Japan, Singapore and Australia the majority of interest is still with institutional clients.

Montanari suggested the greatest opportunities for ETF sales generally were with Chinese insurance companies starting to diversify offshore, the increased penetration of discretionary private banking, the low usage of fixed income ETFs and the very limited offshore investment in Indonesia and Malaysia.

ETFs are taking business from mainstream mutual funds, according to Cerulli Associates. The second half of the year kicked off on a sour note for mutual funds, which bled nearly $11 billion in July, dragging down the year-to-date total to $113.7 billion. ETFs rebounded from a dip in assets during June, and reaped flows of $25.3 billion in July.

Cerulli believes the framework of the active/passive debate is changing from an either/or proposition to how both approaches can be used in more customised, objectives-based multi-asset strategies.

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