A Guide to Smart Beta ETF Investing

INTRODUCTION

Smart Beta may be one of those financial terms that raises the ire of some market participants, but its success in spawning a new class of exchange traded funds (ETFs) is indisputable. 

According to ETF provider Invesco Powershares, from 2010 to 2015, Smart Beta ETFs took in  more than 21% of U.S. equity ETF inflows, representing 12% of total ETF industry assets. Market researcher Market Strategies International noted in a January 2016 survey that 45% of all institutional decision-makers expect to allocate more assets to Smart Beta funds in future. (Related: Building a Better Mousetrap with Smart Beta ETFs and What is the Difference between an Index Fund and a Smart Beta Fund?)

Smart Beta strategies currently underpin about 20% of ETFs globally with an estimated $400 billion under management. In May 2016, Blackrock's iShares unit – the world's largest manager of ETFs – projected that Smart Beta ETF assets globally would grow by 19% annually to reach $1 trillion by 2020 and $2.4 trillion by 2025.

Exhibits 1 and 2, from a Morningstar report, show the growth in Strategic Beta exchange-traded product (ETP) assets for the U.S. and their share of the overall U.S. ETP market respectively (Morningstar prefers to use the term Strategic Beta in place of Smart Beta). Morningstar estimated that in June 2015, the U.S. had $450 billion in Strategic Beta ETP assets, accounting for 90.5% of the $497-billion global market for these assets.  

Exhibit 1:

Exhibit 2:

But what exactly is Smart Beta? To understand the term and its significance, we first have to delve into the arcane world of alpha and beta.