Todd Rosenbluth, senior director of ETF research for CFRA Research, says appeal for smart beta users is both for those who were already comfortable with plain vanilla ETFs and want to reduce their risk profile or enhance returns to complement existing ETF asset allocations; and those who’re shifting from costlier actively managed mutual funds to cheaper and more transparent smart beta ETFs.
But for those who haven’t tried smart beta ETFs, what keeps them away? Rosenbluth doesn’t think it’s cost versus plain vanilla ETFs, as there are many smart beta ETFs, like those from BlackRock or Charles Schwab that charge 20 basis points or less. Rather, he sees need and complexity behind advisors’ reticence to switch.
“If you’re an advisor running an asset allocation strategy, there’s little wrong with a market-cap-weighted approach and keeping it simple,” he noted.
Cerulli Associate’s Shapiro concurs: If an advisor has to explain why the multifactor product she used significantly lagged the broader market, the complexity of these ETFs may mean that more than one thing caused underperformance, complicating explanations.
Tyler Cloherty, senior manager at Casey Quirk, says advisors could be hesitant to use smart beta ETFs if it’s not easily obvious “what’s truly driving the value behind those strategies and whether or not it actually makes sense in terms of the long-term investment philosophies.”
David Schneider, founder of Schneider Wealth Strategies, says when using these ETFs, he sticks to the basic factors, such as size and value, since the academic research backs up those strategies: “I’m more comfortable with those factors on a long-term basis,” adding that he uses these to capture potential outperformance.
FactSet’s Kashner says so far the achievement aim of smart beta strategies might not be working out. Looking at risk-adjusted performance calculations over about the past eight years, she says the overwhelming majority of funds perform in line with the risk taken, while the outliers are more likely to underperform—and a very rare few outperform.
That’s not to say advisors haven’t found legitimate needs for them. Craig Bolanos, CEO of Wealth Management Group, says he uses low-volatility funds to reduce a client’s equity portfolio risk.
“There are a lot of rational investors who desire the typical balanced portfolio—50% stocks, 50% bonds—who can’t bring themselves to allocate 50% of their portfolio to bonds when the 10-year Treasury is yielding so little,” he said.
CFRA’s Rosenbluth says the increased use of smart beta strategies may be from institutional issuers using them in-house. While that might speak to the lack of broad adoption, he suggests the fund family may be using the ETFs as a way of getting exposure to the approach instead of using mutual funds. One example of likely institutional use is the jump in assets in the John Hancock multifactor products, Rosenbluth adds.
The flows into risk mitigation smart beta ETFs likely reflect the current market conditions as a way to diversify portfolios, instead of just looking for market-cap returns, BBH’s McNinch says.
Bolanos says he’s concerned some advisors have unrealistic expectations for some factors like low volatility during market dislocations. He says by using an ETF like USMV, he reduced drawdowns during the fourth quarter sell-off, and the ETFs performed exactly as he expected: “If the industry lost 20%, and I lost 13%, I consider that a hell of a win.”