The “relentless march” of more complex exchange-traded funds (ETFs) has curtailed a downward trend in fees and put pressure on income strategies’ dominance of the smart beta market.
A global guide to the industry produced by data provider Morningstar has found the growth of the market in Europe is increasingly being driven by the rise of more complicated strategies.
Of the 58 new smart beta ETFs in the 12 months to the end of June 2016, more than half were linked to ‘multi-factor’ strategies that represent “a way for ETF providers to differentiate their product offerings and maintain profit margins”, according to the report.
As the name suggests, multi-factor products combine different styles, including the likes of value and low-volatility investing, with the aim of improving risk-adjusted performance versus a conventional benchmark.
In the year to June 30, the products increased their overall market share by 7 percentage points, to 13 per cent of the European smart beta industry, and now have $5.2bn (£4bn) in assets.
Their rise appears to have come at the expense of further growth in dividend-weighted products, which continue to account for 43 per cent of the smart beta market in Europe.
Morningstar noted the products did not see any “meaningful growth” in market share over the period, but products in this sector continue to rank among the largest in the industry. Six of the ten largest smart-beta ETFs in Europe are dividend-based strategies, all of which are run by either iShares or SPDR, the region’s two largest providers.
Passive research analyst Kenneth Lamont said in the report: “In the equity universe, we have seen a clear trend toward increasing complexity. Multi-factor funds have proved to be one of the biggest winners.”
Industry profit margins have been squeezed in many areas as popular strategies become commoditised – typified by Vanguard’s entry into the market with a ‘factor ETF’ product range charging fees of 0.22 per cent, below the industry’s weighted average of 0.39 per cent.
Multi-factor products, however, have partially reversed this trend.
“The proliferation – and popularity – of these pricier multi-factor offerings has offset the downward pressure on fees for the more-vanilla exposures. The net result is that average fees charged by strategic-beta [ETFs] in Europe have levelled off following a fall the previous year,” Mr Lamont said.
Morningstar said it expected fees to resume their fall as the multi-factor market matured, with assets gravitating towards the cheaper offerings and forcing providers to once again reduce fees.
Aside from multi-factor strategies, Morningstar also highlighted strong growth in low-volatility and minimum-variance funds, whose market share rose by 6 percentage points to 19 per cent and a total of $7.7bn in assets.
Overall, the 12 months to July saw a 25 per cent increase in assets across the European industry, taking total AUM to $41bn spread across 268 products.
But Morningstar said this growth remained concentrated in the equity space. There are just 12 “non-traditional” fixed income smart beta products in Europe, accounting for just 1.6 per cent in assets.
“The majority of product development remains focused on equity strategies, with all but seven of the new strategic beta [ETFs] launched over the past year tracking equity indexes,” the report added.
KEY NUMBERS
31bps Weighted average fee in Europe for non-smart beta ETFs
39bps Weighted average fee in Europe for smart beta ETFs
