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ETF & index leaders foresee another eventful decade of smart beta

By: Ron Bundy, CEO, Benchmarks North America

In case you haven’t heard: Smart beta – including products based on the FTSE RAFI™ Fundamental Index™ – is growing and broadening. According to Morningstar, smart beta is growing faster than both the broader exchange traded product (ETP) market and the global asset management industry. From June 2014 to June of 2015, worldwide assets rose from $396 billion to $497 billion; and in the United States, “strategic” beta ETPs account for approximately 21 percent of total ETP assets. So it’s safe to say smart beta has arrived.

But where does it go from here, and why should investors care? I was privileged to explore the near and long term prospects for smart beta with a distinguished panel at Schwab IMPACT 2015. Tony Davidow, Alternative Beta and Asset Allocation Strategist for The Schwab Center for Financial Research, moderated our panel which also included Rob Arnott, founder and chairman of Research Affiliates, and Dan Draper, Managing Director of Global ETFs at PowerShares.

Panelists broadly agreed that smart beta is a catalyst, rapidly changing the investment landscape and driving growth. At FTSE Russell we’ve felt this first hand from clients: 60-70% of new product requests we receive from exchange traded fund (ETF) providers are for smart beta indexes. And our recent financial advisor survey confirmed smart beta use is prevalent and broadening: 68% of advisors who use ETFs say they are incorporating smart beta ETFs into their client portfolios and more than 70% of advisors are adopting more than one smart beta approach.

Panelists credited Research Affiliates, led by Rob Arnott, for helping to fuel today’s boom in smart beta indexes with the launch of RAFI Fundamental Index, a decade ago. In 2005, Rob and his team came up with an alternative to traditional market cap weighted indexes. And it was in fact working with FTSE that the first fundamental indexes – the FTSE RAFI Index Series – were launched. These indexes broke the link between stock weight and stock price by weighting index constituents by fundamental economic size measures rather than by stock price.

Rob and his team were actually viewed as revolutionaries at the time, as was FTSE. In fact, he joked that their new approach was met with a mix of cheers as well as jeers from the investment community. Well, time and track record has proved the validity of this approach and fundamental has opened the door for many new smart beta index innovations in recent years. “It’s been a fun and fast decade,” said Rob. Dan Draper reinforced that smart beta ETFs are poised to become progressively more popular as portfolio building blocks given the demand for new solutions to serve sophisticated investor audiences’ increasingly complex needs. Plus, the current market environment is fuelling interest in smart beta ETFs tied to low volatility indexes, such as the PowerShares S&P 500 Low Volatility Portfolio which is based on a subset of stocks from the S&P 500 with the lowest realized volatility over a 12-month period.

Interestingly, Dan also touched on technology and its role in smart beta index and ETF innovation and growth. He noted technology’s impact on ETFs; the progression of technology and intraday trading capabilities on the major equity exchanges has helped facilitate the use of ETFs by individual investors, while technological advances at global index providers have helped fuel the design of more precise indexes able to dissect markets creatively to provide more discreet tools for investors.

A by-product of smart beta innovation has been an advanced discussion with advisors, beyond simple education to next level discussions on portfolio construction and implementation. As Tony Davidow succinctly put it, “the dialogue among financial advisors and investors has moved from whether smart beta indexes work to how to use them.”

Yet all panelists generally agreed there remains a need for education. Dan further added that education will remain key as investors and their advisors continue to see the characteristics of smart beta indexes – low cost, broad representation, significant investment capacity, transparency, and liquidity.

© 2015 London Stock Exchange Group companies.

London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.

Opinions expressed by Ron Bundy of FTSE Russell, Tony Davidow of The Schwab Center for Financial Research, Rob Arnott of Research Affiliates and Dan Draper of Invesco PowerShares are as of December 15, 2015, and are subject to change. And opinions expressed by Mr. Davidow, Mr. Arnott and Mr. Draper do not necessarily reflect the opinions of FTSE Russell or the London Stock Exchange Group.

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