Robo-advisers and smart beta may be fashionable products, but they are relatively untested on providing long-term investment performance, argues Seth Merrin, chief executive of electronic trading venue Liquidnet.

Merrin and Lee Porter, Asia-Pacific head of Liquidnet, said the rapid expansion of passively managed products at the expense of active fund assets had led the trading businesses of active and passive fund managers to start intersecting.

“When you [as a passive investor] own 3% of a company, your order becomes fairly significant, so you are beginning to have passive guys having to act more like active [players], and actively trade stock [just to keep meeting their passive index tracking],” said Porter. “And actives are moving towards the passive game with smart beta and other look-alike products.”

While passively invested assets are growing globally, Merrin was sceptical about both robo-advisers – algorithm-based tools that use exchange-traded funds (ETFs) to build portfolios – and smart-beta investment strategies.

“They’re like [new cross-border payments system] blockchain; a new shiny object,” he said during a visit to Hong Kong last week. “All these companies are going towards it, but will any of them be any good at it?”

He cited the fact that the hedge fund industry as a whole had failed to enjoy much in the way of good returns for several years, until the most recent financial quarter. “Will [US investment services firm] Charles Schwab suddenly outperform [with its robo-advice products] what massive [hedge] funds could not do?” Merrin asked.

Globally hedge funds gained +2.9% in the third quarter, posting their seventh consecutive monthly gain, bringing YTD performance to +4.2% as of September 30, according to the Hedge Fund Research Fund Weighted Composite Index. The industry returned -1.12% in 2015 and +2.98% in 2014.

Merrin is not alone in raising questions over the potential success of robo-advisers; AsianInvestor has reported on the challenges such businesses face in challenging the established wealth managers. 

Smart-beta skepticism

Meanwhile, Merrin also voiced doubts about smart-beta products, which typically track benchmarks or factors other than traditional market capitalisation, such as dividend or volatility weightings.

“Smart beta is also a shiny new object," he noted. "It’s active managers’ response to [the success of] passive funds; they are twisting to it and offering passive-like strategies while still charging more. And hopefully, God willing, it works and stems the tide [of active manager asset outflow].”

Of course, many investors do not share Merrin’s doubts; funds based on smart beta are growing fastResearch house ETGFI estimated that assets invested in smart-beta exchange-traded products stood at $429 billion on June 30, while BlackRock – an admittedly biased observer – has predicted that smart-beta ETF assets will top $1 trillion globally by 2020. 

And Asian institutional investors – such as New Zealand Superannuation Fund, Taiwan's Bureau of Labor Funds and Hong Kong’s Hospital Authority Provident Fund – have been handing out smart-beta mandates. 

Moreover, Deborah Bannon, investment business leader for Greater China at Mercer, said the strategy offered value to asset owners when used carefully. 

“We don’t like to use the terminology ‘smart beta’, but factor investing is a theme and has a place in clients’ portfolios,” she told AsianInvestor. “It offers several possibilities with via idiosyncratic or other strategies.”

Asset owners are increasingly having to consider other approaches to investing, Bannon noted, as simpler strategies such as cap-weighted indexes “don’t get you to where you need to be [in terms of returns]”.

Liquidnet operates dark pools, specialising in transacting big orders among large asset managers. It also has Asian asset owner clients, said Porter, particularly Australian superannuation funds, as they seek to bring trading teams in-house to cut costs.