[The following "ETF Issuer Perspective" is sponsored by Invesco PowerShares]
For the second year in a row, Market Strategies International, in collaboration with Invesco PowerShares, examined the growing trend in the utilization of smart-beta exchange-traded funds (ETFs) in the institutional market. The results of the latest study—The Evolution of Smart Beta ETFs—reveal that smart-beta ETFs have further penetrated the institutional market and are poised for additional growth moving forward.
Last year was a landmark year for ETFs. In 2014, investors added a record-high $240.4 billion to U.S.-listed ETFs. In addition, the industry has achieved record-high net inflows in each of the last three years, and there are now more than 1,450 U.S.-listed ETFs with a collective assets under management (AUM) of nearly $2 trillion.1 Standing on the success of this larger ETF evolution, smart-beta ETFs have shined in recent years and continue to gain momentum, particularly in the institutional market.
In the simplest terms, smart-beta ETFs follow indexes based on alternative weighting methodologies. Many of these alternative weighting methodologies (such as low volatility, high dividend and fundamentally weighted) have historically delivered favorable risk-adjusted returns and varying returns across different market regimes. As a result, institutions are increasingly looking to smart-beta ETFs as a complement to and a replacement for both their traditional market-cap-weighted ETFs and their actively managed positions.
A Widening Trend
Overall, smart-beta ETFs accounted for over 17% of U.S. ETF net inflows in 2014, despite representing less than 11% of the total assets. Today there are more than 350 smart-beta ETFs available in the U.S. comprising over $230 billion in AUM, up from just 212 products and $64.8 billion in 2010.1 Over the past year, institutional decision-makers—including public and private pensions, endowments and foundations, and registered investment advisors who manage institutional assets—have become more familiar with the smart-beta category.
Consequently, more than one-third of those currently using ETFs are now using smart-beta ETFs, up from 24% last year.
Following are key findings from this year's study:
- 6 in 10 institutional decision-makers are now familiar with smart-beta ETFs, up from 54% last year
- 1 in 3 institutional decision-makers indicate they are currently using smart-beta ETFs
- Accessing specific factors and reducing costs remain the top reasons for using smart-beta ETFs
- Among a variety of available smart-beta products, high-dividend funds are the most widely used
- Lack of familiarity with smart-beta ETFs remains the No. 1 barrier to increased adoption
- Nearly two-thirds of institutions indicate they are likely to increase their use of ETFs over the next three years
- Over the next three years, institutions plan on increasing their use of smart-beta ETFs more than any other category (including market-cap-weighted ETFs)
When looking at the ETF category as a whole, institutional decision-makers have a wide range of options. Despite representing a low proportion of total ETF assets in the institutional market, smart-beta ETFs saw the highest year-over-year increase in institutional usage: from 24% in 2013 to 36% in 2014.
The momentum appears to be shifting toward smart-beta ETFs as the industry has introduced more nonmarket-cap-weighted funds. While the proportion of ETF assets invested in market-cap-weighted ETFs dropped from 75% to 68% from 2013 to 2014, the asset proportion invested in smart-beta ETFs increased from 7% to 13%.
Interestingly, usage of active ETFs (products that mimic traditional mutual fund strategies in an ETF structure) has remained flat year-over-year in the midst of a growing number of active ETF filings and increased Securities and Exchange Commission attention.
IMPORTANT INFORMATION FOR EXHIBIT A
Beta is a measure of risk representing how a security is expected to respond to general market movements. Smart beta represents an alternative and selection-based methodology that seeks to outperform a benchmark or reduce portfolio risk, or both. Smart beta funds may underperform cap-weighted benchmarks and increase portfolio risk.
We'll dig further into the reasons for the growth and expected growth of smart-beta ETFs in subsequent articles.
1Bloomberg L.P., as of Dec. 31, 2014.