Assets under management (AUM) in smart beta exchange-traded funds are on course to push above $500bn by the end of 2016 and reach nearly $800bn by 2020 if current growth rates for the sector are maintained, according to WisdomTree Europe. However, the ETF provider believes the actual figure will be a lot nearer to $1tn by the end of the decade as two important trends – the desire for tailored ETFs and for low-cost alternatives to active funds – move more firmly into play.
Nizam Hamid, head of strategy at WisdomTree Europe.
Commenting on how the increasing popularity of passive investment exposures may be supportive of growth in the broad ETF industry, Nizam Hamid, head of strategy at WisdomTree Europe, writes: “Globally, passive funds have grown four times faster than active products since 2007, according to the latest study by Morningstar, with assets in passives now standing at approximately $6trn.
“There is a long way to go of course, especially in Europe where ETFs account for just 3.7% of assets held in mutual funds. That figure is far below the US where they account for almost 17%, but this in itself presents an opportunity as there is clearly scope for European investors to add ETFs, either to gain core or satellite exposure to various asset classes.”
While growth in the global ETF industry continues to gather momentum, with significant potential for expansion in Europe, smart beta funds are finding increasing popularity with investors. At the end of June 2016, 40% of total flows into European ETFs had gone into smart beta products year-to-date, according to WisdomTree. Even more compelling, over this period market cap-weighted ETFs suffered outflows of $9.1bn, while alternatively weighted strategies enjoyed net inflows of $5.7bn.
According to Deborah Fuhr, managing partner at ETFGI, a London-based consultancy for the ETF industry, investors are choosing more sophisticated solutions to broad market investing in response to specific challenges faced in the markets today. Commenting on the reported flows into smart beta products during June, Fuhr said: “The preference for volatility factor ETFs/ETPs, with $2.2bn in net inflows during June, shows that investors are seeking to better manage their risk exposure during a period of heightened market uncertainty while significant net inflows of $1.7bn into dividend factor ETFs/ETPs serves as a reminder that investors are still hunting for income opportunities in a prolonged low-yield environment.”
“Investors are cottoning on to the idea that, rather than weighting by market cap and simply having large positIons in the biggest stocks regardless of their underlying performance, it makes sense to screen much more actively,” added Hamid. “Creating a tailored index based on a specific set of rules can, over time, capture positive market trends, and if such solutions can outperform market cap indices (while costing less than active funds) it should help boost growth substantially.”
In today’s low-yield environment, the emphasis placed by investors on reducing costs is expected to continue being supportive of ETF net inflows, particularly as a growing body of research suggests that the majority of active mutual funds are not providing value relative to their higher costs.
For example, research from S&P Dow Jones released in March 2016 showed that more than 85% of active equity funds in Europe underperformed their benchmark over the last ten years, according to the Year End 2015 Europe S&P Indices Versus Active Funds (SPIVA) Scorecard. This lends further support to the notion that despite decreasing fees in active mutual funds, low cost passive products such as ETFs provide better value for money.
WisdomTree believes that, while active mutual funds are likely to continue slashing fees in the face of growing competition from the ETF industry, this process will happen at ‘a snail’s pace’. This process will continue to be a boon for the ETF industry, including smart beta funds. Hamid writes: “Smart beta solutions priced well below active equivalents will continue to benefit from this alongside the wider passive industry, especially given the cost-conscious environment we find ourselves in.
“… This shift in thinking among ETF investors should not be underestimated, especially as investors continue to look more at outcomes and long-term goals.”