In terms of growth, assets invested in smart beta ETFs listed globally increased by 32.3% to US$658 billion in 2017. Net inflows into smart beta ETFs amounted to US$71.75 billion in 2017. In fact, December 2017 marked the 23rd consecutive month of net inflows into smart beta ETFs globally with US$8.45 billion of inflows in December alone, according to data from ETFGI, an independent research consultancy.
Although the increase in smart beta ETFs is still substantially lower than the 40.3% increase in market cap-weighted ETFs, experts agree that the difference can be attributed more to a function of the latter’s legacy than their future.
The factors used in smart beta investing are elements that allow an investor to categorize assets by their principal characteristics. Examples of commonly used factors are value (value stocks), low volatility (low volatility stocks), and momentum (high momentum stocks).
These factors can be used to create a portfolio, known as single factor smart beta, or in combination with other factors, known as multi-factor smart beta. The characteristics of each factor can be built by the investor to suit his particular investment objective, which makes it a bespoke factor solution.
In Asia, smart beta ETFs have been attracting a lot of interest, particularly from regional as well as domestic institutional investors who are seeking new ways to enhance their portfolio’s performance and diversify their risk.
“In our experience working with institutions and financial intermediaries, we generally see three types of ETF allocators. You have your strategic, your tactical and transactional. We see application of smart beta strategies most prevalent with strategic investors when they’re seeking a particular outcome. For tactical buyers it’s seeking to articulate a certain risk premia view or factor exposure over the intermediate to shorter term,” says John McCareins, managing executive and head of Asia-Pacific asset management for Northern Trust.
One trend that has been strongly pushing smart beta ETFs in general, but particularly in Asia, is increasing utilization in multi-asset portfolios by investors and fund managers.
“We think the discussion will continue, particularly in a multi-asset context, where we see more use of ETFs to gain exposure efficiently and to trade around that exposure effectively,” McCareins says.
Many institutional investors are also leveraging smart beta ETFs to gain more tactical exposure, strategic-and-tactical exposure, or transactional exposure for their portfolios. Other institutional investors are also using smart beta ETFs in accordance with their governance procedures.
Other investors also find it easier and quicker to gain market access by using smart beta ETFs when compared to going through a full manager search and then selecting a pooled fund or setting up a segregated account mandate.
“We have seen more and more mandates for multi-factor smart beta investment strategies in recent years, as investors seek to have a more diversified factor exposure which captures factor premium in a more robust manner across different economic cycles,” says Sunny Leung, head of ETF, indexing and smart beta sales, North Asia, of Amundi Asset Management.
Amundi gained more than 30% of total European inflows on multi-factor smart beta ETFs. This range of products, built in partnership with the ERI Scientific Beta, was completed in 2017 with a multi-smart ETF for the US equity market. Amundi launched two market cap-weighted ETFs in Hong Kong in 2016, and is also studying the possibility of launching more ETFs in Hong Kong, although no time frame was given.
One principal attraction of using smart beta ETFs is that it’s a flexible and convenient way for institutional investors to gain access to an existing smart beta strategy.
“It’s a very convenient way to get into investments in smart beta. It can be purchased in smaller sizes, it can be traded the same as a stock. Investors can use smart beta ETFs to gain exposure to the factors of their interest. For example, if the investors want to participate in the market’s upside or if they foresee there’s downside risk in the market, they can always use a smart beta ETF to achieve their goals or objectives. It can be used both strategically and tactically. A lot of times because of its convenience of use it is used tactically,” says Taie Wang, vice president and deputy head of research for smart beta of State Street Global Advisors.
Perhaps an indication of the growing interest in smart beta ETFs is the fact that fund managers have begun launching Asian-focused smart beta ETFs in a bid to fulfill requirements from their clients seeking such Asian-focused products.
For example, two China-focused smart beta ETFs launched by Premia Partners, a Hong Kong-fund manager, have attracted good inflows since they were launched in September 2017.
The first of Premia Partners’ smart beta ETFs, which invested in state-owned (SOE) businesses, saw its assets increase from US$42 million (on launch date) to US$59 million in three months, with a performance of 12.9%. It’s second smart beta ETF, which invested in new economy stocks also saw its assets increase from US$46 million (on launch date) to US$55 million, with performance of 7.8% in the same period.
“The main methodology behind our two ETFs is looking at commonly used factors in global markets and then applying them to A-shares. First, we try to see which factors work best with A-shares and which factors do not. Then we select the factors which worked well with A-shares and then we apply these factors to our strategy,” says David Lai, partner and co-chief investment officer of Premia Partners Company Ltd.
Although Asian-focused smart beta ETFs launched by Asian-based fund managers are still few, the experience of Premia Partners is perhaps an indication of a bright future for Asian smart beta ETFs.
In any case, ETFs have the potential to offer market participants access to smart beta strategies in a lower cost, liquid and more transparent delivery format. With ETFs, investors can combine allocations to different smart beta strategies in a wide range of global markets and asset classes.
“Increasingly, investors may capture a of range different market factors within a single product. Taking the S&P 500 universe for example, there are ETFs tracking around 20 different smart beta indices – some target single factors such as value, low volatility, yield, momentum and quality; others target combinations such as value and momentum; low volatility and high dividends; and so on,” says Tim Edwards, senior director, index investment strategy, S&P Dow Jones Indices. There are also indexes tracking similar themes in other market segments such as mid-caps, additional geographies or more focused subsets such as sectors. “Smart beta strategies are essentially forms of active management, so they come with the associated risks of tracking error and underperformance, as well as the traditional caution that the past may not be a guide to the future,” Edwards says. “The biggest challenge for investors when using smart beta ETFs can be the uncertainty over what to do with the range of tools they are being presented with. That is to say, it is not always easy to find out how the underlying index works, how it differs from otherwise similar-sounding alternatives, and under what circumstances it is likely to outperform. Beyond individual products, the question of how to effectively combine different smart beta strategies (or even time them) remains a topic of debate,” Edwards says.
Although the increase in smart beta ETFs is still substantially lower than the 40.3% increase in market cap-weighted ETFs, experts agree that the difference can be attributed more to a function of the latter’s legacy than their future.
The factors used in smart beta investing are elements that allow an investor to categorize assets by their principal characteristics. Examples of commonly used factors are value (value stocks), low volatility (low volatility stocks), and momentum (high momentum stocks).
These factors can be used to create a portfolio, known as single factor smart beta, or in combination with other factors, known as multi-factor smart beta. The characteristics of each factor can be built by the investor to suit his particular investment objective, which makes it a bespoke factor solution.
In Asia, smart beta ETFs have been attracting a lot of interest, particularly from regional as well as domestic institutional investors who are seeking new ways to enhance their portfolio’s performance and diversify their risk.
“In our experience working with institutions and financial intermediaries, we generally see three types of ETF allocators. You have your strategic, your tactical and transactional. We see application of smart beta strategies most prevalent with strategic investors when they’re seeking a particular outcome. For tactical buyers it’s seeking to articulate a certain risk premia view or factor exposure over the intermediate to shorter term,” says John McCareins, managing executive and head of Asia-Pacific asset management for Northern Trust.
One trend that has been strongly pushing smart beta ETFs in general, but particularly in Asia, is increasing utilization in multi-asset portfolios by investors and fund managers.
“We think the discussion will continue, particularly in a multi-asset context, where we see more use of ETFs to gain exposure efficiently and to trade around that exposure effectively,” McCareins says.
Many institutional investors are also leveraging smart beta ETFs to gain more tactical exposure, strategic-and-tactical exposure, or transactional exposure for their portfolios. Other institutional investors are also using smart beta ETFs in accordance with their governance procedures.
Other investors also find it easier and quicker to gain market access by using smart beta ETFs when compared to going through a full manager search and then selecting a pooled fund or setting up a segregated account mandate.
“We have seen more and more mandates for multi-factor smart beta investment strategies in recent years, as investors seek to have a more diversified factor exposure which captures factor premium in a more robust manner across different economic cycles,” says Sunny Leung, head of ETF, indexing and smart beta sales, North Asia, of Amundi Asset Management.
Amundi gained more than 30% of total European inflows on multi-factor smart beta ETFs. This range of products, built in partnership with the ERI Scientific Beta, was completed in 2017 with a multi-smart ETF for the US equity market. Amundi launched two market cap-weighted ETFs in Hong Kong in 2016, and is also studying the possibility of launching more ETFs in Hong Kong, although no time frame was given.
One principal attraction of using smart beta ETFs is that it’s a flexible and convenient way for institutional investors to gain access to an existing smart beta strategy.
“It’s a very convenient way to get into investments in smart beta. It can be purchased in smaller sizes, it can be traded the same as a stock. Investors can use smart beta ETFs to gain exposure to the factors of their interest. For example, if the investors want to participate in the market’s upside or if they foresee there’s downside risk in the market, they can always use a smart beta ETF to achieve their goals or objectives. It can be used both strategically and tactically. A lot of times because of its convenience of use it is used tactically,” says Taie Wang, vice president and deputy head of research for smart beta of State Street Global Advisors.
Perhaps an indication of the growing interest in smart beta ETFs is the fact that fund managers have begun launching Asian-focused smart beta ETFs in a bid to fulfill requirements from their clients seeking such Asian-focused products.
For example, two China-focused smart beta ETFs launched by Premia Partners, a Hong Kong-fund manager, have attracted good inflows since they were launched in September 2017.
The first of Premia Partners’ smart beta ETFs, which invested in state-owned (SOE) businesses, saw its assets increase from US$42 million (on launch date) to US$59 million in three months, with a performance of 12.9%. It’s second smart beta ETF, which invested in new economy stocks also saw its assets increase from US$46 million (on launch date) to US$55 million, with performance of 7.8% in the same period.
“The main methodology behind our two ETFs is looking at commonly used factors in global markets and then applying them to A-shares. First, we try to see which factors work best with A-shares and which factors do not. Then we select the factors which worked well with A-shares and then we apply these factors to our strategy,” says David Lai, partner and co-chief investment officer of Premia Partners Company Ltd.
Although Asian-focused smart beta ETFs launched by Asian-based fund managers are still few, the experience of Premia Partners is perhaps an indication of a bright future for Asian smart beta ETFs.
In any case, ETFs have the potential to offer market participants access to smart beta strategies in a lower cost, liquid and more transparent delivery format. With ETFs, investors can combine allocations to different smart beta strategies in a wide range of global markets and asset classes.
“Increasingly, investors may capture a of range different market factors within a single product. Taking the S&P 500 universe for example, there are ETFs tracking around 20 different smart beta indices – some target single factors such as value, low volatility, yield, momentum and quality; others target combinations such as value and momentum; low volatility and high dividends; and so on,” says Tim Edwards, senior director, index investment strategy, S&P Dow Jones Indices. There are also indexes tracking similar themes in other market segments such as mid-caps, additional geographies or more focused subsets such as sectors. “Smart beta strategies are essentially forms of active management, so they come with the associated risks of tracking error and underperformance, as well as the traditional caution that the past may not be a guide to the future,” Edwards says. “The biggest challenge for investors when using smart beta ETFs can be the uncertainty over what to do with the range of tools they are being presented with. That is to say, it is not always easy to find out how the underlying index works, how it differs from otherwise similar-sounding alternatives, and under what circumstances it is likely to outperform. Beyond individual products, the question of how to effectively combine different smart beta strategies (or even time them) remains a topic of debate,” Edwards says.
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