Smart beta strives to enter the mainstream

Increasingly, institutional investors are being wooed by asset managers touting the possibilities offered by smart beta investing. Will it become a core strategy?
Smart beta strives to enter the mainstream

As active fund managers continue to underperform, institutional investors across the globe are seeking out other means to gain returns. One way has been to delve more into alternatives, but increasingly investors are looking at the possibilities conveyed by smart beta, otherwise known as factor investing. 

This is the subject of our seventh forecast for the Year of the Rooster (see below for the others published so far; the full list appears in the February/March issue of AsianInvestor magazine).

Will smart-beta be broadly adopted as a mainstream investment strategy?
Answer: No

Stock-picking managers should be worried by recent research by rating agency Moody’s. It predicts that passively invested assets in the US will outstrip those in active strategies by 2024. The report, issued in February, said passive investments accounted for $6 trillion of assets globally and 28.5% of assets under management in the US, and that this figure would exceed 50% in the next four to seven years.

A sizeable and growing chunk of the passive universe are smart beta strategies, which aim to improve on market returns by tracking indexes weighted by factors other than traditional market capitalisation. Institutional investors are increasingly handing out such mandates, and smart beta exchange-traded funds are rapidly gaining traction. Globally, smart beta ETF assets stood at $497.4 billion as of end-November, having almost trebled from $174.3 billion at end-2013, according to research firm ETFGI.

Moody’s and investment specialists—including active managers—expect this to continue. Some cited smart-beta credit and multi-factor strategies as particularly ripe for growth. We expect them to be proved correct.

The key reason? Low cost relative to performance: in short, smart beta can do things that active managers do, but for less money. The large majority of active managers worldwide underperform their benchmarks and typically charge 1% or more for the pleasure of doing so.

A startling 84% of US active funds underperformed the S&P 500 in 2015 and by 98% over the 10 years to end-2015, Standard & Poor's said. Emergingmarket funds fared better, yet still underperformed their benchmark by 70% in the five years to December 2015.

So it’s not surprising that asset owners have been moving more into smart beta in recent years.

Index provider FTSE Russell published survey findings in June 2016 in which 36% of institutional investors said they had a smart-beta allocation, up from 26% the year before. Moreover, 39% of respondents said at least 20% of their equity portfolio was invested in smart beta, broadly double the proportion who said the same the previous year.

Despite widespread reservations about smart beta its usage globally is set to rise steadily — and especially in Asia, where take-up has been slower than in Europe and the US. It will be adopted more widely — but probably not as a standalone portfolio allocation — in Asia over time, and perhaps not as a mainstream strategy, at least not this year.

AsianInvestor's other predictions for the Year of the Rooster:

Will China A-shares be included in MSCI's global emerging-market indexes this year?

Will there be any major blowups in the ETF industry?

Which investments will perform best this year?

Will more countries vote to leave the European Union?

Will the Bank of Japan be forced to rethink its 10-year bond yield target?

How many rate hikes will the US make this year?

Will Donald Trump spark a trade war with China?

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