A study of European investors’ perceptions has found only 30 per cent of intermediaries that currently use smart beta said their clients found the products too complex, a fall of 22 percentage points from 12 months previous.
The drop in concerns over complexity was accompanied by a sharp rise in allocation expectations, with UK investors suggesting they could double their allocation to smart beta products by 2019 to account for as much as 25 per cent of portfolios.
Only 11 per cent of European advisers cited client demand as a reason for using the products, however. Conversely, 45 per cent of non-users suggested a lack of client demand had held them back from foraying into the space.
The general rise in the acceptability of smart beta use was highlighted in a report from Invesco PowerShares. The study, which surveyed the views of fund selectors across Europe, also showed a rise in those allocating to smart beta from active management allocations.
Prior to the 2016 report, the proportion of investors that allocated to smart beta at the expense of either passive or active holdings was around even: 47 per cent said they had reassigned part of their active management allocations, with 43 per cent shifting from passive and 10 per cent using new money.
However, in this year’s report, 54 per cent said they had switched to smart beta at the expense of active management products, with 43 per cent from passive and three per cent from new money.
Bryon Lake, report author and head of Invesco PowerShares Emea, said a potential doubling of allocations to smart beta would represent a “massive shift” in how portfolios would be built.
However, the continued attractions of active management could limit growth. Despite the general optimism around smart beta from existing investors, scepticism remained among those who do not currently use the products.
Just over two-thirds of non-users said they had stayed away from smart beta products as they favoured active management, though this percentage has fallen from 83 per cent in 2015. Some 42 per cent said there was still insufficient evidence the strategies work.
Investors willing to buy the funds are most likely to use low-volatility, fundamental and dividend strategies. One area for growth appears to be in products tilted towards quality stocks – where 59 per cent of investors said they would increase allocations. Other areas of interest were in tracking momentum strategies or combining factors.
Mr Lake said: “We will see growing adoption in the quality space. Our most successful product has been a multi-factor one where we combined high dividend and low volatility. There is a good investment reason for combining the two, and investors are getting more comfortable using factors in their portfolio and multi-factor will [grow].”
Non-users also said they saw potential in combining factors and using momentum strategies.
Mr Lake added: “Non-users are still using active funds heavily in their portfolio, so [factors] they look towards are the types where they can reconcile what they are trying to achieve with their active managers.”
Unsurprisingly, users of smart beta strongly favoured strategies producing income and reducing risk or volatility. However, several investors had found multiple uses for equally weighted indices, including the 40 per cent who said they allocated for alpha generation.
Mr Lake added: “The best practitioners will figure out how to kill two or three birds with one stone. An equally weighted portfolio will have a tendency to mid and small caps, which historically outperform large caps, and it will be diversified as it acts differently to the cap-weighted index. It’s also risk reduction by taking the weighting out of the largest companies.”
Though UK investors moving into the space said they were primarily motivated by lower fees, intermediaries across Europe said the cost of smart beta, while lower than that of active funds, was becoming increasingly difficult to justify.
Smart beta rise offsets downward fee trend
The proliferation and growing popularity of complex smart beta products leading to a change in fee dynamics in the ETF market, according to recent research from Morningstar.
The ratings agency said the “relentless march” of multi-factor exchange-traded funds (ETFs) had curtailed a downward trend in fees and put pressure on income strategies’ dominance.
The net result is that average fees charged by smart beta ETFs in Europe have levelled off following a fall the previous year.
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.
These products increased their market share by 7 percentage points, to 13 per cent of the European smart beta industry, and now have £4bn in assets.
Key numbers
66%
Proportion of UK smart beta users who cited cost as the primary driver
59%
Proportion of European investors who said they were likely to use quality-focused products
