Year of the Rooster: Did smart beta hit the mainstream?

AsianInvestor asked market experts their views about smart beta products and gave our opinion on whether it would hit the mainstream. Find out whether we were right.
Year of the Rooster: Did smart beta hit the mainstream?

In recent years, investors have had a few priorities when it comes to putting their money to work. One has been the desire to put more money into low-cost passive strategies; another was an interest in diversifying how they invest, in order to tap unusual areas of opportunity and to mitigate risk. 

Fund managers have been quick to seek to meet both needs, and one way they have sought to do so is through smart beta funds. Their concerted promotion of these products led us to tackle the outlook for this product class in last year's Year of the Rooster prediction questions:     

Will smart beta be broadly adopted as a mainstream investment strategy?

Answer: No

Smart beta funds and products mirror an underlying index that is based upon factors other than market capitalisation. Most invest in stocks, but instead of placing the biggest weighting on the largest companies by market value, they measure which company shares offer the biggest dividends, or are cheapest, or benefit most from rising markets. 

Their focus upon these factor-based indices are meant to help differentiate their returns—and ideally beat the standard market performance. For fund houses, they have the benefit of being a bit more expensive than completely passive mutual funds or exchange-traded funds. 

Smart beta has been gaining traction across the world as investors have sought new ways to improve their annual returns. And some have put money into smart beta funds. In fact quite a few have; at the end of 2017, smart beta funds had passed a record $1 trillion in cumulative assets under management, according to funds data house Morningstar (ETF research consultant ETFGI posts the total somewhat lower, at $658.35 billion, but that was still a 32.3% rise on a year earlier). 

That's pretty impressive, but is it the mainstream? We didn't think so a year ago and don't believe it is today. While a case can be made that smart beta is becoming a serious investment option, it's hard to argue that it's as important an investment option as active stock or bond funds, or their passive equivalents.

As we reported yesterday passive investing into exchange-traded funds now constitutes around $5 trillion in total AUM, according to data provider ETFGI, and many more institutional investors passively invest via index mutual funds. Passive funds and ETFs are believed to account for 29% of the US stock market alone, according to Moody's, which was worth $30 trillion in January.  

Additionally, the fastest growing passive funds last year were all cap-weighted ETFs and these funds grew at a faster rate than their smart beta rivals. ETFGI noted that "assets in market cap ETFs increased by 40.3% in 2017, which is significantly more than the 32.3% increase in Smart Beta assets."

In other words, while smart beta's overall assets grew, standard ETFs were even more popular. For most retail investors, in particular, smart beta funds remain an esoteric idea and one they are unlikely to engage with. 

But that doesn't mean these hybrid investing strategies won't gain more appeal. Keep an eye out for more smart beta growth in the future, particularly if the market volatility that global stock markets witnessed during early February has aftershocks. It might just be that some smart beta funds can manage such conditions better than simple index-trackers.

Low volatility is one of the most important and popular smart beta fund factors, after all.

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