So-called ‘smart beta’ funds could have attracted more business if the industry standardised the language used to describe the products, according to Lipper’s Detlef Glow.
The head of Europe, Middle East and Africa research said smart beta funds were passive-based products that track indices weighted on non-standard factors, such as companies’ valuations, size or share price volatility.
Mr Glow said while academic research had shown the potential for outperformance by such strategies compared to their conventional tracking cousins, the industry had not been as successful as it might have been because of a blizzard of differing terminologies.
“Since much of the sales process of mutual funds and exchange-traded funds (ETFs) is done by product marketing, European ETF providers have found a number of different names for their smart beta offerings to differentiate themselves from their competitors,” he said.
“From my point of view, the industry should not use different terms for these strategies. Instead, they should use the term ‘factor investing’, since this really describes what the index/fund is doing.
“Otherwise, it could happen that investors won’t buy a fund because they do not understand why one promoter is using a different vocabulary to describe the same strategy as one of its competitors.
“This could also be one reason ETFs based on factor indices have not gathered more money in the past. Even though this market segment is rather new and has shown good growth, it may have been possible that ETF promoters could have gathered even more money.”
Mr Glow also said the multitude of factors that smart beta funds can choose added a layer of complexity.
“Another reason investors might be shy about buying into factor-based indices can be seen in the fact that the index concepts are rather complex and lead to a lot of activity on the constituent level,” he said.
“In this regard, some market participants see factor investing as an active strategy and call ETFs that follow these strategies active ETFs.
“But this is only half the truth. The ETF by itself is a passive vehicle that replicates its underlying index, and in the case of factor investing these indices can be called active because of the very high turnover of constituents in some cases.”
Smart beta is growing in prominence in the UK, with groups like Legg Mason eyeing a way to bring the expertise of QS Investors – a smart beta provider it recently purchased – to the UK.
Seven Investment Management last year ditched the majority of its conventional tracker exposure in its Asset Allocated Passive fund range in favour of smart beta holdings.
Mr Glow said investors looking to use smart beta funds needed to consider that most performance analysis conducted by smart beta providers was “based on back testing”.
“Nevertheless, it is very helpful to run the respective analysis on long-term data sets to evaluate the behaviour of the factor strategy in different market environments,” Mr Glow said.
