Despite reluctantly accepting the phrase “smart beta” to define alternatively weighted index investing, U.S. institutional investors remain divided on how and when to embrace these strategies and products, particularly exchange-traded funds, in their investment allocations.
Recent survey data from FTSE Russell and Invesco PowerShares, separately, show divisions among institutions and their interest in smart beta.
Roughly one-third (32%) of U.S. institutional investors with more than $10 billion in assets surveyed by FTSE Russell in January and February had evaluated smart beta and chosen not to implement. And while 27% of large U.S. institutions surveyed had made an allocation, they lag large European investors, 68% of which said that they had allocated to smart beta strategies.
Still, 34% of U.S. institutional investors surveyed by FTSE Russell said they are evaluating or plan to evaluate smart beta in the next 18 months. This syncs with the 31% of U.S. institutions surveyed by Market Strategies International for Invesco PowerShares in late 2014 that said they haven't used smart beta ETFs due to “lack of familiarity.”
The wavering views are not wholly unfounded. As asset managers continue to develop narrower smart beta products, funds are piling up in the category with few assets and little trading.
In fact, the top concerns of asset owners who evaluated smart beta but did not make an allocation were that they “do not believe [the strategies] have investment merit” or that “the strategies had limited track records,” both selected by 24% of respondents in the FTSE Russell survey.
Yet the buzz around smart beta has placed factor exposures—particularly value, size, quality, volatility, and momentum—top-of-mind for pensions and endowments following the fiscal year-end close, according to Sharcus Steen, investment consultant at Cambridge Associates in Arlington, Va.
“Smart beta has reinforced that these investors need to know what they own when it comes to factors,” Mr. Steen says. “What views am I taking now and how might an isolated smart beta strategy affect my overall exposures?”
For U.S.-based pensions and endowments, moving to smart beta strategies and ETFs often requires a re-evaluation of their investment strategy, says Daniel Gamba, head of Americas Institutional iShares Business at BlackRock in New York.
“Shifting to a factor-based process requires an institution to take a more tactical approach to their portfolio; it's more of a risk-based model,” Mr. Gamba says. “It also begs the question: What is the mix of factors we should hold at any time?”
He adds that the smart beta debate has prompted some clients to reassess what they are receiving from fundamental active managers and whether they could gain access to similar exposures at a lower price by using ETFs with factor-based strategies.
According to Morningstar, there are 384 strategic beta (Morningstar's preferred term) equity ETFs among 1,023 ETF equity products as of August 18. These products account for 26% of total equity ETF assets, but gathered 39% ($82.3 billion) of inflows over the past year.