What’s Working In Smart Beta ETFs

Not too long ago, smart-beta ETFs were the focus of all the hype in an industry fascinated with the new and novel ways ETF issuers were slicing and dicing the market.

A little less long ago, some naysayers started to say smart beta had had its day, as investors returned their attention to cheap, easy-to-understand and easy-to-implement core beta strategies. No bells and whistles required.  

In reality, as a segment, smart-beta ETFs find themselves somewhere in the middle—neither the hottest new thing in town, nor obsolete and forgotten.

From the get-go, complexity and, traditionally, a higher price tag, have been head winds for adoption of these strategies. This is still true today, especially in an ETF market where fee compression is inching closer and closer to zero.

New Launches, Outsized Growth

But smart-beta ETFs keep on coming, and some keep on growing at an impressive rate. In the past 12 months (as of late February), 77 new smart-beta ETFs came to market—or roughly a third of all ETFs launched in the past year, according to FactSet data. There are more than 1,000 smart-beta ETFs on the market today.

What’s more, asset growth in this segment outpaced the broader ETF market as well as vanilla ETF asset growth on a percentage basis in the past year. While vanilla funds saw total assets under management (AUM) grow 4.3% in the time period, smart-beta fund assets grew 10.9%, according to FactSet data. Today smart-beta ETFs command $880 billion in total combined assets.  

“The past 12 months have been good for ‘smart beta,’ in contrast to its below-market growth rate in 2016 and 2017,” FactSet's Director of ETF Research Elisabeth Kashner said. “SPY was the elephant in the room, losing over $20 billion in outflows during the period, thereby lowering the growth rates for vanilla funds. Massive liquidity cuts both ways.” 

Factors Working In Space

The biggest smart-beta ETF in the market today is the Vanguard Value ETF (VTV), with $47 billion in total AUM.

As a factor, value has been a “winner” in recent months, Kashner says, and VTV has dominated that corner of the market. Not only is this fund huge, it keeps growing. In 12 months, VTV grew from a $37 billion ETF to a $46 billion fund.

“Of the specific strategies that started the time period with $10 billion or more in AUM, winners were value, multifactor, fundamental and low volatility,” Kashner added.

After a dip late in 2018, VTV is now up 11.7% so far in 2019.

Other Winning Factors

Another segment that has been resonating with investors in the past year is low volatility, and no ETF comes even close to the iShares Edge MSCI Min Vol U.S.A. ETF (USMV) in this space.

The fund has been hugely popular with investors in the past year, attracting flows of $8 billion in 12 months, and today boasts more than $25 billion in total AUM. USMV is today the largest-largest smart-beta ETF on the market. By comparison, close competitor Invesco S&P 500 Low Volatility ETF (SPLV) saw $2 billion in net asset inflows in the same March-March period, and today has $10.1 billion in total assets.

USMV is up about 12% year-to-date, and has rallied almost 13% in the past 12 months.  

Multifactor Winners

On the multifactor front, two smaller ETFs have stood out in the past year with impressive growth: the Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC) and the Hartford Multifactor Developed Markets (ex-US) ETF (RODM), Kashner notes.

GSLC grew nearly 65% in size, going from $2.9 billion in total AUM in March 2018 to $4.5 billion a year later. RODM, meanwhile, has seen sevenfold growth, hitting more than $1.8 billion in total AUM today—up from only $280 million 12 months ago.

Both of these ETFs have had a good run year-to-date, posting double-digit gains—although RODM remains down 2.5% on an annual basis.

Fundamental Winners

Finally, among fundamental ETFs, two funds deserve a closer look, each practically doubling in size in the past year, according to FactSet data. 

The iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL) neared $10 billion in assets by March 2019—up from $4.5 billion a year earlier—while the iShares Core Dividend Growth ETF (DGRO) grew to $6.1 billion in total assets in 12 months.

Year-to-date, both strategies have delivered double-digit returns, with QUAL now up more than 17% in 2019, and DGRO up 12.7%. Like other equity strategies, these ETFs too faced a dip in late 2018.

Charts courtesy of StockCharts.com

What’s Working In Smart Beta

At the end of the day, beyond specific factors or pockets of smart-beta ETFs that resonate with investors at any given time, two key trends are driving smart-beta ETF asset growth.

The first has nothing to do with innovation, but everything to do with cost.  

“What caught my eye in this space [in the past year] was not inventiveness in repacking stocks, but the appeal of the cheapest funds,” Kashner said. “Strategic funds with expense ratios of 0.10% or less took in $34.5 billion; the 0.11-0.20% group took in $23 billion; 0.21-0.30% took in $17.3 billion; but only $2.8 billion went to funds charging more than 0.30%.” 

VTV, the biggest smart-beta ETF on the market today, has a price tag of 0.05%. Investors are paying $5 per $10,000 invested for this massive, hugely liquid smart-beta ETF that trades at pennywide spreads. VTV is not only cheap for smart beta, it’s cheap for an ETF in general. 

Costlier Funds Still Relatively Cheap

The iShares Russell 1000 Growth ETF (IWF) and the iShares Russell 1000 Value ETF (IWD) aren’t that far behind VTV, with $43 billion and $38 billion in total AUM, respectively. They cost significantly more, at 0.20% in expense ratio each, but that’s still less than most smart-beta strategies.

Rounding out the top five smart-beta funds in terms of size, the Vanguard Growth ETF (VUG) reached $37 billion in total AUM in the past year, while the Vanguard Dividend Appreciation ETF (VIG) is today the fifth-largest smart-beta ETF, with $33 billion in assets. VUG also costs only 0.05% and VIG costs 0.08%, or $8 per $10,000 invested.

Clearly iShares and Vanguard dominate the space in assets—much like they do in other asset classes and segments of the ETF market. Cost is no doubt a big part of it.

But keeping a lid on cost is also helping relatively younger, smaller players like Goldman Sachs find traction. Consider that GSLC, one of the smart-beta ETFs from Goldman’s ActiveBeta lineup that has found strong following, costs only 0.09%—or $9 per $10,000 invested.

The second thing to note is that smart-beta asset growth is also driven by a trend in the ETF space known as “bring your own assets,” Kashner says. Outside of iShares’ and Vanguard’s massive success in the space, and outside of ultra-low-cost strategies, newer issuers that are backing their proprietary ETFs with their own clients’ money have also found success in getting traction in the space. Note for example that Goldman is one of the top shareholders in GSLC.

If it’s indeed true that assets beget assets, BYOA is as smart a strategy to get a new smart-beta fund going in an ever-crowding segment as any other, and some issuers are finding it a winning strategy. 

Contact Cinthia Murphy at [email protected]