Institutions Fuel Smart Beta ETF Liquidity

May 07, 2015 Are ETFs allowing institutions to be more tactical than before? Is tactical asset allocation more of the norm today among institutions?


Hunnicutt: It depends on the institution and how much they may make tactical decisions inside of their allocations. A hedge fund, for example, has to do things much differently than a large insurer or an endowment. But I do think that there are folks who are starting to consider and evaluate the potential opportunities in being more tactical because the tools to do so—ETFs—are now available.


I think smart-beta ETFs also allow you to have some specific outcome-based types of opportunities. If I'm a pension plan and I want to lower my risk, I can do that by using a low-volatility equity basket versus just buying bonds, particularly given where the rate environment is right now. Smart-beta ETFs give me more options. Is there a particular type of smart-beta ETF that institutions are favoring these days?


Hunnicutt: Fundamental weighting is one type we've seen people have interest in. And it's been around for a while. Having a longer track record in these strategies helps. PRF [PowerShares FTSE RAFI US 1000 Portfolio (PRF | A-88)], for instance, is nearly 10 years old now. Institutions like the fact that they have a significant track record they can look at.


But smart-beta ETFs all have personality. You can look at something like a momentum-weighted index versus a high-quality index. The market environments in which they perform and add value are going to be different. All of that impacts their adoption rate. The report pointed out that high-dividend funds are among the most widely used today. Is this just a phenomenon that's tied to the ongoing hunt for yield?


Hunnicutt: What we hear most often is that yield is a lot more scarce today than it was 10 years ago. Institutions are trying to find ways to help re-factor some of that income or that dividend. Certainly, dividend-paying stocks or a basket of dividend-paying stocks is a way that they're able to do that.


Dividend strategies have also been one of the earlier types of smart-beta tools to come out. So, maybe they've had a little more time to get traction and to show how to perform in different environments. I’ll say that the length of time on the market as well as the current yield environment are two factors leading institutions to have a high interest in dividend-focused ETFs. Did anything surprise you in your research as far as how institutions are using smart-beta ETFs or what types of funds they favor? Any shocker?


Hunnicutt: Compared to the report we did last year—this was our second annual—there wasn't a significant change in outcome. We were very encouraged to see the level of interest in and increase usage of ETFs in general. But it was interesting to see that smart-beta ETFs are the type of vehicle most institutions say they intend to use more of. Some 62 percent said they plan to increase use of smart-beta ETFs, more than any other category. And that number is up from last year. We expect it to grow further. Is there any pocket of the market where institutions see a need for product innovation? Are there any flavors of smart-beta ETFs missing?


Hunnicutt: There’s a push for multifactor ETFs, although we're already there in many cases. If you look at SPHD [PowerShares S&P 500 High Dividend Portfolio (A-53)], that’s a great example of taking two factors to create a unique outcome of high-dividend-paying stocks that have less volatility. But I think we’re going to continue to see similar funds evolve that combine things like factors and strategies.


There's a lot of interest in the current environment around currency-hedged-type products. Smart-beta ETFs that incorporate a currency hedge with better tactical factors could be an area where people might have real interest. 



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