Smart beta products have been hailed as “the next big thing” — so many times, in fact, that it’s become a cliché. The marketing muscle behind these products is equally enthusiastic — just google “smart beta ETFs” and look at the ads. But before you take a bite of these passive investment treats, shouldn’t you know what’s in them? How do you distinguish one smart beta exchange-traded fund from the other? And just how smart — and how beta — is that smart beta ETF you are considering?
In the days of simple equity portfolios, investors knew exactly what they were getting: maybe some Ford, some U.S. Steel, some GE. But the investment landscape has changed. Actively managed strategies — not to mention active managers — are being pushed aside by a burgeoning selection of passive alternatives.
The numbers don’t lie. The flow of money into actively managed funds has declined steadily, while flows into passive funds have ballooned. In fact, 2015 saw more than $207 billion flow out of actively managed funds, while inflows into passive funds soared for the second straight year by more than $410 billion. And half of all the ETFs launched in 2015 were smart beta ETFs.
So passive investing is hot, and smart beta products are the hottest of all beta offerings. But for all that heat, total returns in 2015 left most investors a bit cold, with actively managed returns falling 2.2% and passively managed returns falling even further, down 2.7%. That is not outperformance by anyone’s measure.