Smart Beta Gets More Complex To Charge Higher Fees

Smart beta funds, which do not weight stocks in an index by the traditional means of market capitalisation to generate returns, have exploded in popularity to a total of 844 exchange traded funds worldwide with $497 billion in assets, according to Morningstar’s latest report. But there is a catch.

In its research called A Global Guide to Strategic Beta Exchange-Traded Products, published today, it found that so-called strategic beta indexes of new ETPs are becoming more complex and harder to understand.

“As these strategies become increasingly nuanced, looking to infuse elements of an active manager’s thinking into an index, investors’ collective due-diligence burden will continue to increase commensurately,” it read.

Price War Continues

And as annual average weighted costs for Europe-listed strategic beta ETPs fall from 0.44 percent to 0.39 percent, Morningstar has “begun to see providers respond to these developments by providing evermore innovative and complex new strategies, for which a premium can be charged.”

In Europe alone, smart beta ETPs have grown their assets by 18.6 percent over the past 12 months to $32.1 billion at the end of June this year – fourfold growth over the past five years, and has even outpaced the broader ETP industry. Investors now have a choice of 183 smart beta ETPs in Europe, a third more choice than this time last year: 30 new products have already been launched so far in 2015.

Finding A USP And Charging More

But in a crowded market, providers have to find ways to differentiate their new products. One example cited in the report is the iShares MSCI Target US Real Estate UCITS ETF (USRE) and the iShares MSCI Target UK Real Estate UCITS ETF (UKRE), which both replicate the performance of physical real estate via a “complex algorithm” to allocate funds to a combination of liquid assets.

Not all new products, complex or otherwise, have made the cut. In the last year, 11 of these smart beta funds were closed in Europe, eight of which were in the commodity / energy space as they fell victim to tumbling commodity prices.

However, old habits die hard. The most popular strategic funds in Europe remain in familiar categories: dividend screened/weighted funds top the list t 53.2 percent of assets as investors seek income, followed by minimum volatility at 13.1 percent, and non-traditional commodity ETPs at 6.4 percent. Multi-factor ETFs, launched by the likes of iShares this summer, are creeping into favour at 5.4 percent.