On average, strategic beta ETPs underperformed their respective cap-weighted benchmarks during the first five months of 2020 as the Covid-19 pandemic roiled markets.
Morningstar’s report found widespread underperformance among strategic beta ETPs during the Covid-19 market turmoil.
Strategic beta defines a set of investment strategies that seek to obtain alpha, reduce risk, or improve diversification through the use of alternative index construction rules to traditional market capitalization-based indices.
The approach emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way.
According to Morningstar’s Strategic Beta Landscape report, however, strategic beta’s lackluster showing this year is, in many instances, directly linked to the underlying factor tilts.
Morningstar classifies strategic beta ETPs according to 11 categories (commodity, dividend, fixed income, fundamentals, growth, momentum, multifactor, other, quality, risk-oriented, and value).
The report notes that many strategic beta equity ETPs, particularly those in the dividend, fundamentals, multifactor, and value groups, tend to tilt toward stocks with smaller market capitalizations and lower valuations. Those two factors (small size and value) underperformed considerably during the first five months of the year.
This was especially true for US-listed strategic beta ETPs which tend to focus on their home equity market where small size and value factor exposures were particularly punished.
For US-listed strategic beta ETPs, every group except for commodities performed worse, on average, than their cap-weighted benchmark.
The outperformance of strategic beta commodity ETPs has been credited to lower exposure to front-month futures contracts in oil markets. Due to acute market stress brought on by an unprecedented supply glut, oil futures were in a state of ‘super-contango’ earlier in the year, leading to significant rolling costs for investors in front-month contracts.
On the fixed-income side, strategic-beta ETPs tend to take greater credit risk than their respective benchmarks. This hurt performance as Covid-19 led to a slew of credit downgrades, widening spreads, and a spike in defaults.
The results among Europe-listed strategic beta ETPs were mixed with six of 11 groups underperforming. ETPs within the dividend, fundamentals, multifactor, and value groups all also notably underperformed their benchmarks. Growth and momentum strategies, however, were significantly rewarded during this period.
Source: Morningstar.
Strategic beta maturing
Morningstar’s report also examined the state of the global strategic beta ETP market during 2019, finding that the pace of new product launches had slowed while fee competition continued to intensify, both signs that the space is maturing.
The number of strategic beta ETPs increased by just 1.2% globally in 2019. In the US, however, the number of new product launches was the lowest since 2010 and, for the first time ever, was eclipsed by the number of strategic beta ETPs that were shuttered, providing further evidence that the menu has been oversaturated.
Among the 563 strategic beta ETPs within Morningstar’s global database, 120 (21%) saw their fees decrease during 2019 with a median decline of 0.02%. Meanwhile, 44 (8%) saw their fees inch higher by a median level of 0.02%. The remaining 398 (71%) products remained unchanged.
With pressure continuing to mount on fees, issuers are taking steps to differentiate themselves through offering strategic beta ETPs with increasingly complex investment approaches. These include multifactor ETPs, factor-timing products, and new variants of single-factor exposures.
Dividend strategic beta ETPs continue to rank as the most popular strategy, reflecting the record low interest rate environment and secular growth in the demand for income.
Low volatility ETPs also continued to gain market share with $24.8bn net inflows during 2019, double the amount they raked in during 2018.