Smart beta to grow faster than broader ETF market
ADVERTISEMENT FEATURE – Invesco PowerShares has been leading the “ETF Intelligent Revolution” since 2003, so when it comes to understanding the key growth drivers at work in this space, the firm is uniquely placed.
In January 2014, the firm published a report with Cogent Research entitled The Evolution of Smart Beta ETFs. Two key findings emerged in relation to institutional investor sentiment towards smart beta: first, one in four institutional decision makers now use smart beta ETFs; second, 53 percent said they would look to increase their allocations over the next three years.
“Within the US, we estimate that the current smart beta market is roughly USD200bn. We see that growing to between USD450-500bn over the next three years. We see smart beta growing two to three times faster than the overall ETF industry,” says Dan Draper (pictured), Managing Director of Global ETFs at Invesco PowerShares.
To understand the growing adoption of smart beta products among institutions one needs to look at both the macro and micro level. From a macro perspective, post-2008 has seen global monetary policy create a perniciously low interest rate environment. This has led to a knock-on effect within the investment industry where correlations across asset classes have been pushed higher and volatility – especially in equities – was dampened.
“Post-2008, that combination of macro factors really benefited traditional market cap-weighting. Markets were moving up and down together. You had a high level of correlation across markets and investors weren’t being rewarded as much for asset allocation and security selection strategies,” comments Draper.
Today, the macro environment has started to shift. Global economic growth is slowly returning, equity volatility has seen an uptick, and at some point in the near future interest rates will likely rise (at least in the US).
“As we move to more normalised global monetary conditions, and de-correlation among different asset classes and geographies, that should favour smart beta and help add to the alpha creation process,” says Draper. “While our smart beta ETFs are index based, the product development phase is a very active process as we work with our index providers to understand exposures and methodologies,” he adds.
At the micro level, as the depth of liquidity in smart beta products deepens, institutions will have more ways to gain smart beta exposure. Historically, many institutions have used bank-issued products such as swaps and structured products. But with banks facing rising capital requirements, traditional asset management solutions via ’40 Act funds, UCITS funds and ETFs, stand to benefit in this smart beta demand surge.
“We believe that with increased liquidity coming into the smart beta ETF space, we will be able to capture some of that growth,” says Draper. “Low volatility strategies, momentum, commodities that offer forward-rolling yield optimisation capabilities – all of these products will likely be increasingly considered by institutions whereas in the past they may have only had access to bank-issued products.”
Most likely, large institutions will still use banks for sophisticated services and take advantage of the more commoditised area of smart beta by using ETFs in a fiduciary-friendly, transparent fund wrapper to better manage their risk budgets.
“What smart beta represents is actually really powerful. It’s a form of performance attribution. Invesco PowerShares offers both single and multi-factor products; the FTSE RAFI suite for example, uses a combination of single factors together in a way that can add real value to investors’ portfolios,” concludes Draper.