“Smart beta” Exchange Traded Funds, at times besmirched by certain hedge fund managers, appear to be gaining strength among institutional investors, according to a recent report.

Smart Beta

Institutional investors favoring smart beta ETFs

Smart beta ETFs have experienced tremendous growth, finding favor with 25 percent of institutional decision makers in the past year, according to a white paper from Cogent Research published by Pensions & Investments magazine. What’s more, in 2013 fully 29 percent of asset flows found their way into smart beta ETFs while the category holds just 19 percent of the total assets in the ETF industry, according to Bloomberg as of December 31, 2013. This highlights how the industry is fast growing, much to the chagrin of certain traditional hedge fund managers, some of whom view the product as competition for their higher fee actively managed offerings.

Smart Beta

Smart Beta

“I don’t know what ‘smart beta’ is,” Richard Ferri Portfolio Solutions said at a recent Morningstar conference. “It’s a marketing phrase. I would be surprised if 10% of the people running around saying ‘smart beta’ even understand what beta is.”

Alpha vs Beta

“Beta” has been traditionally defined as performance being driven by the general move of the market, as opposed to “alpha,” which refers to an individual manager’s skill at actively making investments. Those traditional lines appear to be bluring. According to the report, industry professionals define “smart beta” as featuring predetermined rules, quantitative approaches used to a achieve a specific objective, such as reducing portfolio volatility. Institutional managers often consider smart beta products to contain an degree of active management.

Change In usage

Change in ETF

“Smart beta is the flavor of the day,” Chris Brightman, of Research Affiliates, stated at the recent Morningstar event. However, the flavor of the day appears to be gaining in popularity. A majority in the Cognet research, 59 percent, expect smart beta ETF usage to grow in 2015, while only 2 percent expect its usage to decrease. Those who haven’t used smart beta cite a general lack of familiarity and a short product track record.

Smart beta ETFs help making tactical adjustments to asset allocation

The primary reasons for utilizing a smart beta EFT are the ability to make tactical adjustments to asset allocation, access higher beta strategies, its use in portfolio completion and to reduce volatility and higher fees normally associated with actively managed products. Invesco, Powershares are top choices in terms of the number of product offerings, assets under management and brand recognition, a key component among the institutional set, the report noted.

Smart Beta

Smart Beta

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