Smart beta's popularity among institutional investors has grown substantially in the past couple of years — and experts believe that will continue in 2014 and beyond.
Because smart beta is not yet an official designation, and because investors and money managers have different names and definitions for the strategies that fall under the name, it's difficult to quantify growth.
Whether it's called smart beta, advanced beta, exotic beta, strategic beta or factor-based investing, this set of equity and fixed-income strategies based on non-cap-weighted indexes appeals to investors seeking competitive returns in a cost-efficient manner.
Data from Towers Watson & Co. shows its institutional investor clients made more than twice as many new investments in smart beta strategies during 2013, approximately $11 billion, than the year before. All told, Towers Watson's clients globally have now allocated more than $32 billion to smart beta strategies.
“Up until five or 10 years ago, investors only had the option of passive or active investing,” said Fabio Cecutto, a senior investment consultant in Towers Watson's New York office. “However, there's always been academic evidence suggesting that there's been ways to exploit market inefficiencies.”
Lynn Blake, chief investment officer of global equity beta solutions at State Street Global Advisors, Boston, said that SSgA has seen its smart beta business increase by roughly 25% during the past three years.
SSgA's recent research also shows investors see advanced beta as more of a replacement for active strategies than passive and are three times more likely to fund a smart beta allocation from active than from passive.
The Oregon Investment Council, which runs the $67.1 billion Oregon Public Employees Retirement Fund, approved three smart beta allocations over the past 2½ years, accounting for nearly $2 billion.
“We like active management, but these rules-based factors offer a dependable, lower cost alternative to many active funds, especially when implemented internally,” said Michael Viteri, senior public equity investment officer for the investment council in Tigard.
While Oregon manages its smart beta portfolios internally, not all investors have that ability, so money managers are poised for that opportunity.
At BlackRock Inc., “we are seeing more clients asking questions about this category,” said Amy Schioldager, New York-based senior managing director and global head of beta strategies.
According to Ms. Schioldager, BlackRock, which manages approximately $45 billion in what she calls strategic beta, started seeing investor interest in low-volatility strategies in 2009 following the financial crisis. Clients were seeking protection on the downside yet wanting to participate in the equity markets. So, the firm launched its first strategy benchmarked to minimum volatility indexes in 2010.
Now, the firm's clients are using this strategic beta to complement their traditional index strategies.
“We're seeing it being used across the full spectrum of markets: across equities, across emerging markets (equities), across developed markets,” she added.
Said SSgA's Ms. Blake: “In the last five or six years, there's been an even stronger demand for smart beta, in particular for low-volatility and valuation-tilted strategies.”
She added that part of the appeal of such strategies is that “they're very rules-based, objective and transparent,” and that the fees “are significantly lower,” which helps with performance.
Although fees for smart beta strategies are lower than for active strategies, clients will pay a premium compared to traditional passive management. Through smart beta, however, investors can achieve investment performance in a way that meets their investment objectives. Disappointment with the costs and performance of active management, according to Ms. Blake, is among the main reasons investors switch to smart beta.
SSgA, which specializes in passive management, manages $72 billion in what it brands as advanced beta strategies.
