The past 12 months have seen a wave of new smart beta launches that cover a broader range of equity strategies and, increasingly, offer options for fixed income or mixed-asset investors.
But will smart beta steal a march on active fund management, or will its complexity be its undoing?
Smart beta generally moves away from market cap-weighted indices and into factor-weighted indices – the factors may be high dividends, volatility or value/growth metrics.
Recent launches include the S&P Global 1200 Dividend Stability Low Volatility index, designed to track companies that score highly for dividend yield and growth, as well as low volatility.
Cap-weighted indices generally work poorly for fixed income, skewing any investments to the most indebted countries or firms, and so passive fixed income products have struggled to gain traction.
Smart beta fixed income offers a potential solution. For example, Lombard Odier and ETF Securities are launching a series of weighted fixed income exchange-traded funds. These are weighted according to fundamental factors for government and corporate issuers, and are designed to identify issuers with the best ability to repay. This might be GDP or debt-to-GDP for governments, while for corporate issuers it will include revenues or indebtedness.
The smart beta market is set to grow in size and complexity. In its report ‘The future of fund management’, investment bank Nomura says that while the smart beta market is dominated by minimum variance or fundamental indexation/value strategies, it expects to see more sophisticated strategies emerge, including long-short or mixed-asset class.
Lombard Odier head of marketing and business services Ben Horsell says: “Smart beta allows investors to allocate to different areas – value, growth, lower volatility – on a modular basis, but people are looking at how these factors might be put together and combined.”
Smart beta is finding some support internationally. US services firm Towers Watson reports that its global institutional investment clients allocated more than $8bn (£5.1bn) to smart beta strategies during 2014. They now have total exposure of around $40bn across a range of asset classes. This compares with a $32bn exposure to smart beta strategies at the end of 2013 and $20bn in 2012.
But smart beta has yet to find a significant market in the UK, and there have been concerns over the complexity of some of the products launched. Fund selectors have struggled to see the value in a product where fees are, in some cases, almost as high as for an active fund.
HSBC head of passive equity Joseph Molloy says that where smart beta has been adopted, it has not usually been at the expense of active funds.
He explains: “We have found that people use them to shape a portfolio slightly differently. They may use them tactically and strategically for risk reduction, to get access to higher-dividend stocks, or to focus on value or fundamentals.”
Mr Molloy points out that turnover in smart beta indices is two to three times higher than for market cap-weighted indices, which gives them the headwinds of higher costs. That said, these fees are not as high as traditional active funds and the products offer similar diversification benefits.
