‘Smart’ investing finally making the grade in Asia

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Already popular in North America and Europe, smart beta investment strategies are now becoming a fixture in Asian portfolios too as institutional investors rethink the value of active management and look for ways to reduce risk.

Smart beta adoption among Asia Pacific investors jumped to 48% in 2017 from 38% the year before, according to a FTSE Russell survey released in late May. The global adoption rate increased to 46% from 36% over that span. Among those polled from this region, more than seven out of ten said a smart beta index was an appropriate basis for an investable product.

“The trend observed over the past three years of increasing global growth and adoption of smart beta indexes continues in 2017,” said Rolf Agather, managing director of research at FTSE Russell. “It is clearly not a fad, but now widely recognized as a meaningful set of new tools.”

Smart beta is a passive investment method that innovates on the traditional approach of tracking stocks according to their market capitalization by instead using alternative factors like volatility or dividend payouts. This appeals to institutional investors like sovereign wealth funds and insurance companies who are often subject to strict performance standards and are looking for low-cost, bespoke strategies to grow their assets under management.

The trend is not without risk, however, as more and more investments are taken from the oversight of a trusted human advisor and pumped into automated trading vehicles. There is also a lack of consensus on the long-term impact of many of the new factors favored under smart beta strategies.

Globally, assets invested in smart beta exchange traded funds (ETFs) and products rose to a record US$560 billion at month-end in February from US$534 billion the month before, according to industry consultant ETFGI. BlackRock said in May 2016 that the global smart beta market size would reach US$1 trillion by 2020 and US$2.4 trillion by 2025.

Nearly 90% of the smart beta assets reported by ETFGI were listed in the US. Asia has a long way to catch up, with Asia Pacific ex-Japan only accounting for about US$5 billion worth of the total.

“It is clearly not a fad, but now widely recognized as a meaningful set of new tools”

That gap should start to narrow as asset managers ramp up their smart beta product suite to accommodate growing demand from investors across the region. A Greenwich Associates report released in February said one out of two Asian investors polled plan to increase smart beta allocations.

“Growing numbers of Asian institutions are introducing smart beta ETFs into their portfolios,” said Andrew McCollum, managing director at Greenwich Associates, in the report.

“Going forward, changes in portfolio management philosophy that depart from the traditional active/passive framework could lead to additional increases in demand for smart beta ETFs.”

The report said that whichever smart beta strategy is favored at a given time reflects the current financial environment. In 2016, after two straight years of flat performance in the MSCI AC Pacific Index, the three most popular strategies cited for this region were income generation, a multi-factor approach and minimum volatility. The minimum volatility strategy was the most popular tilt in 2015.

Growing demand for smart beta has translated into an increasingly broad product suite that covers not only equities but also fixed income and commodities. Aside from volatility and income generation, typical factors used to screen securities include profitability, price momentum, valuation and liquidity.

Index-provider MSCI said this month that a review of its dataset revealed price momentum was the one factor that contributed the most toward performance. BlackRock had an overweight position on momentum factor strategies as of March 31, saying stocks in this area often benefit during periods of economic expansion.

“Going forward, changes in portfolio management philosophy that depart from the traditional active/passive framework could lead to additional increases in demand for smart beta ETFs”

The iShares Edge MSCI International Momentum Factor ETF has increased 16.8% so far this year through July 18 versus a 13.2% rise in the MSCI World ex USA Index over the same period. The ETF’s top three holdings – HSBC, Siemens and luxury goods conglomerate LVMH  – combined for a 7.8% weighting.

A momentum tilt may not work in all market environments, however. A recent UBS study cautioned that only one in five momentum strategies beat their benchmark on an absolute basis over a ten-year period.

The merits of smart beta tilts will continue to be debated, but one consideration likely to support investor interest is the relatively lower fees. The iShares Edge MSCI International Momentum Factor ETF lists a 0.30% expense ratio. That generates significant long-term savings when compared with the average 0.82% fee cited by the Investment Company Institute for actively managed equity mutual funds in 2016.

A lower fee structure is one reason why passive investments have been on the upswing throughout the region. Asia Pacific-focused equity ETFs combined to net inflows of US$29.6 billion and grow in asset size by 6.6% so far this year through July 12, according to Bloomberg data.

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