ETF Strategists Turn Beta Into Alpha

June 05, 2014

Who knew the humble index fund would turn into an alpha generator?

[This article originally appeared in the June issue of the ETF Report.]

Perhaps it was inevitable that the exchange-traded fund would evolve and expand from its original function. It has transformed from a way to easily canvass a single broad asset class such as U.S. equities through a single trade into an efficient way to canvass all asset classes in the pursuit of alpha.

And perhaps it was inevitable that a new class of financial advisors would emerge that would develop and spread to other advisors this concept of "alpha through beta." Indexing pioneer Steven Schoenfeld presciently described at length this idea in his classic 2004 tome "Active Index Investing."

Money keeps pouring in to ETFs as it becomes clear that using this type of cheap, transparent and highly liquid fund with a top-down macro approach is really a better path to asset-allocation investing than using more expensive mutual funds or overly granular individual securities. The growing army of so-called ETF strategists that design active-index portfolios using ETFs and market them to other advisors is steadily moving to center stage in the world of money management.

The latter trend is hardly a surprise. Anyone with experience in the brass-knuckles sales culture of the financial services industry knows that landing clients and thoughtfully running money with a rigorous eye on asset allocation are about as different as night and day. But both are full-time jobs, so the division of labor at the center of the value proposition that ETF strategists offer makes a whole lot of sense.

In any case, you can't argue with the numbers. Assets in U.S.-listed ETFs are rapidly approaching $2 trillion, and hedge funds are increasingly making use of ETFs in their pursuit of outperformance. That's a clear shift away from the stock picking favored by yesteryear's star managers like Peter Lynch at Fidelity's Magellan Fund.

According to Morningstar research, assets in ETF model portfolios marketed by ETF strategists grew by about 40% last year to just shy of $100 billion—almost 6% of the $1.701 trillion that was in U.S.-listed ETFs at the end of 2013. That stellar growth rate came on top of a 50% growth rate in 2012, Morningstar said.

By comparison, assets in U.S.-listed ETFs as a whole rose by 26% in 2013 and 27% in 2012—both well below growth rates in the ETF strategist space, thus demonstrating that ETF strategists are an engine of ETF growth.


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