By Hamlin Lovell, NordicInvestor
“Smart beta” assets have reached $658.4 billion at the end of 2017, up 32.3% year on year, per Morningstar. Much of this resides in products that are based on only one factor concept. The simplest definition of smart beta is any index not based on market capitalisation, which means that indices such as the Russell 1000 growth and value indices can be classified as “smart beta”.
Growth and value
The largest “smart beta” ETFs are the iShares Russell 1000 Growth and Value ETFs (tickers IWF and IWD), worth $41 billion and $36 billion respectively, while the Vanguard Value and Growth ETFs (tickers VTV and VUG) contain assets of $37 billion and $35 billion in turn. Not far behind are the iShares S&P 500 Growth and value ETFs (tickers: IVM and IVE) together worth over $36 billion. Small cap, mid cap, large cap and mega cap value and growth ETFs are also available. Overall, growth and value ETFs have assets above $200 billion.
The second largest category of “smart beta” ETFs are those based on dividend yields, where Vanguard has two products (VIG and VYM) with over $57 billion of assets, iShares has one (DVY) worth $16 billion., and SPDR has SDY worth $15 billion.
The small cap or mid cap value and growth ETFs are combining two factors: the size factor and the value or growth factor. The PowerShares S&P 500 High Dividend Low Volatility Portfolio blends the two factors in its name: high dividends and low volatility
Dividend growth is a variation on the themes, seen in WisdomTree US Dividend Growth Fund (DGRW), but this contains much lower levels of assets – only $2 billion.
Low volatility ETFs are the third biggest category, with the iShares Edge MSCI Min Vol US and EAFE ETFs at $14 billion and $9 billion respectively, while the PowerShares S&P 500 Low Volatility Portfolio has assets of $8 billion.
Currency hedged overseas equities
The fourth most sizeable category includes ETFs offering exposure to non-US equities, but without the currency risk. Wisdom Tree Japan and Europe Hedged Equity Funds (DXJ and (HEDJ) taken together have assets over $13 billion.
A fifth category focuses on industrial sectors, such as MLPs – Alerian MLP ETF (AMLP); natural resources – FlexShares Morningstar Global Upstream Natural Resources Index Fund – (GUNR); biotech SPDR S&P Biotech ETF (XBI) or real estate – iShares Cohen and Steers REIT ETF.
ETFs based on the momentum (or trend-following) factor include the iShares Edge MSCI USA Momentum ETF, with nearly $9 billion of assets, and the PowerShares DWA Momentum Portfolio.
The iShares Edge MSCI USA Quality Factor ETF (QUAL) is based on the earnings quality factor, and contains over $5 billion of assets.
The small cap or mid cap value and growth ETFs are combining two factors: the size factor and the value or growth factor. The PowerShares S&P 500 High Dividend Low Volatility Portfolio blends the two factors in its name: high dividends and low volatility. And some products described as “multi-factor” may only be based on two factors. For instance, the Principal US Mega-Cap Multi-Factor Index (USMC) only seems to be based on two factors: mega cap size, and a tilt to lower volatility companies.
The ERI Scientific Beta indices (a venture of the EDHEC Risk Institute) are based on four smart factor indices: mid-cap, value, momentum and low volatility
The iShares Edge MSCI Multifactor USA ETF (LRGF) is based on four style factors: value, momentum, size and quality, and has assets just under $1 billion.
The ERI Scientific Beta indices (a venture of the EDHEC Risk Institute) are based on four smart factor indices: mid-cap, value, momentum and low volatility, and have now gathered over $10 billion of assets in a range of products run by Global X, Amundi, ETFS and Morgan Stanley: Global X Scientific Beta US, Europe, Japan and Asia ex-Japan (tickers SCIU, SCID, SCIJ an SCIX); Amundi ETF Global and Europe Equity Multi Smart Allocation Scientific Beta UCITS ETF (tickers SMRT and SMRE); ETFS Diversified-Factor US Large Cap, and Developed Europe, Index Funds (SBUS, and SBEU); and Morgan Stanley Scientific Beta Global, and US, Equity Factors UCITS ETF (GEF and USEF).
The EDHEC approach is relatively sophisticated in that the factors are proprietary rather than generic definitions. The fact that four different asset managers have created products based on the EDHEC indices may suggest that a more diversified marketing effort is needed to gather assets for more sophisticated smart beta ETFs. A single firm and a single brand name may not have the breadth of coverage and recognition to attract a critical mass of assets.
Alternative risk premia (ARP) products are also rarely seen in ETF format. Multi-factor products tend to be marketed as alternative risk premia (ARP), which have both short and long exposures (and also often span multiple asset classes)
Other smart beta products might contain models based on six or seven or more factors such as growth, value, dividend yield, low volatility, quality, momentum, and other factors.
From an asset-raising perspective, it seems that simplicity wins out for the ETF market. With a few exceptions, such as the EDHEC “family” of products, the products based on a single factor concept have so far raised many times more assets than those seeking to combine multiple factors.
One possible explanation is that over the past decade, a simple strategy like large cap growth has generated stronger performance. Another is that some investors may prefer to use the single factor ETFs as building blocks and make their own decisions on weighting and timing the individual factors. Another possible reason is that blending multiple factors within the same product adds complication, and could cause confusion. A fourth explanation is simply that the single factor ETFs are much older, and that assets in the multi-factor ETFs may catch up over time as investor education raises awareness and understanding of them.
Not all smart beta strategies are wrapped in ETFs. One of Sweden’s largest alternative asset managers, IPM – Informed Portfolio Management, runs a series of smart beta equity strategies (in addition to its flagship systematic macro strategy) – but not in ETFs.
Alternative risk premia (ARP) products are also rarely seen in ETF format. Multi-factor products tend to be marketed as alternative risk premia (ARP), which have both short and long exposures (and also often span multiple asset classes). At least 50 ARP strategies have now been launched, and they tend to go for a UCITS fund structure, with daily dealing, rather than an exchange listed ETF offering intraday trading.
Smart beta and ARP
“Smart beta” is sometimes conceptualised as the long-only half of alternative risk premia (ARP)/style premia strategies, applied only to one asset class, such as equities or credit. This is accurate for some of the simplest ARP strategies, where splitting them by asset class, and removing the short books, could leave a series of smart beta strategies. But sometimes the jigsaw is not so easy to decompose. Where relative value trades (with one or more long and short legs) are being pursued, or where the optimisation and portfolio construction processes view the long and the short books as a whole, then the long books of an alternative risk premia product are not necessarily a good guide to what a standalone smart beta product might look like.