Smart beta faces pressure to perform

This article is part of
Outlook for 2016: What’s in store?

This year, the focus in the ETF sector is expected to move away from pricing to a debate centred more on the performance after fees, with the growth and success of smart beta continuing and eventually leading to active ETFs.

Arguably, the pricing of core ETFs has already won the battle with mutual funds when it comes to the provision of passive trackers.

Now we are seeing a shift in focus in terms of expectations, as investors become more aware of the opportunities and breadth of asset management benefits the ETF wrapper can deliver for them.

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The focus on performance after fees in the ETF space does not exist here to the same extent it does in the US, but as smart beta picks up momentum in Europe, it can be expected that this will be the direction of travel over the next few years.

So, rather than focus on whether they can get US equity exposure for 4 basis points (bps) or 5bps from different providers, it will be the type of exposure investors are getting that will become more important.

Now that transparent, rules-based smart beta strategies are available for access to income, performance and diversification, smart beta can offer investors the chance for better risk-adjusted returns over the long run in different market environments.

Why this shift to smart beta? Quite simply because everyone along the value chain, from the adviser to the investment manager to the product provider, is under increasing pressure to deliver value-added strategies for investors.

Offering tailored products that suit different macro environments – for example, by providing exposure to European exporters with the euro hedged against the dollar, in the expectation of capturing gains from a fall in the value of the euro – enables all parts of that chain to keep clients happy.

Of course, this focus on specific returns across the passive or passive alpha space is happening to an extent already, but it lags far behind the active space where it is more central.

As smart beta products continue to expand to replicate more and more complex strategies, it will become increasingly important.

It will also help shine a light on some mutual funds that claim to create alpha and therefore charge high fees, but which in reality hug (or even worse, underperform) core benchmarks.

Given the increasing freedom investors have to switch from one share class to another without incurring high switching fees and unnecessary taxes, these products will take tactical asset allocation to the next level for many clients.

Amid all this innovation comes the need to deliver exposures investors want, therefore transparency and performance remain central to ETF innovation.

Hector McNeil is co-chief executive of WisdomTree Europe