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Understanding the “why” of smart beta

By: Rolf Agather, Managing Director of Research

The world of smart beta indexes has evolved to the point where “why” has replaced “what” as the central question on the minds of industry players and watchers. The “what” question has been largely answered, as global asset managers now have a robust and varied toolbox of smart beta indexes at their disposal. As asset owners and consultants increase their use of smart beta indexes, the “why” questions has taken center stage. What are the primary reasons investors give for using smart beta indexes? And why in many cases are they allocating a rapidly increasing portion of their investment portfolio to index-based approaches?

According to the new FTSE Russell global institutional market survey, Smart Beta: 2016 Global Survey Findings from Asset Owners, return enhancement and risk reduction continue to be the primary reasons behind smart beta index adoption with cost savings quickly rising in popularity in 2016. (All the charts in this blog are taken from the survey results).

With 72% of asset owners surveyed using or actively evaluating smart beta, survey findings re-enforce that concerns about volatility, managing the impact of market drawdowns, and the overall transparency of their portfolios in the aftermath of the global financial crisis of 2008-2009 have caused investors to look more closely at smart beta implementation.

Why smart beta?

In our 2014 and 2015 surveys, global asset managers cited return enhancement and risk reduction as equally important drivers for smart beta implementation. While both of these objectives are still stated as strong drivers, the 2016 survey pointed to a growing increase in “cost savings” as a primary objective for asset owners with $10B or more in AUM, while “improve diversification” is more likely to be a primary objective for asset owners with under $1B in AUM.

Evolution of smart beta strategies

Looking more closely at the strategies the global asset managers choose, our 2016 survey found that the strategies have evolved over time, with increasing use of high quality, momentum and multi-factor strategies and declining use of fundamental strategies. In 2016, the top strategies cited by asset owners are “Low volatility,” “Value,” and “Multi-factor combination,” as detailed in the May 26 FTSE Russell Index IDEA.

The percentage of asset owners using five or more smart beta strategies has also increased significantly, from 2% in 2014, to 21% in 2016. The survey further highlights that nearly half of asset owners who are currently evaluating smart beta are evaluating multi-factor combination strategies, and nearly 40% are evaluating low-volatility strategies.

While the drivers stated for smart beta adoption largely focus on concerns surrounding volatility, managing the impact of market drawdowns, and the overall transparency of their portfolios, key differences can be found when looking at how global asset managers view and analyze the strategies, how they vet strategies and how they enhance or re-construct their portfolios.

Over the past three years, our survey has documented global institutional asset owners’ growing interest in smart beta indexes, and in 2016 their growing acceptance and use of the indexes. Clearly, the smart beta “phenomenon” has matured to the point that large numbers of asset owners now consider smart beta indexes to be an important part of the investing toolkit. As leading index providers, we recognize that we must provide much more education and information to asset managers that are using smart beta indexes for a much broader set of objectives than before,. This is an evolving investment landscape and our role as index educators is paramount.


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