Passives grow more complex after surge in asset growth

Figures from the Investment Association show that assets under management in tracker funds have increased from £29.4bn in 2007 to £141bn by the end of 2016. This means the products now account for 13.5 per cent of the industry total funds under management, which is more than double the 6 per cent recorded in 2007. 

Meanwhile, asset growth in exchange-traded funds (ETFs) and exchange-traded products (ETPs) also continues to rise. Research from ETFGI shows that global assets in ETFs and ETPs combined reached $3.9trn (£3trn) at the end of March 2017, compared with just $603bn at the end of 2006. 

Charles Aram, head of Emea at Research Affiliates, explains: “There have been significant tailwinds behind passive investing, with Morningstar data showing the space grew by 18 per cent to $6.7trn globally in 2016. Central to this growth has been the popularity of smart beta.”

However, Mr Aram points out that there are significant challenges: “Product proliferation is one problem as existing providers and new entrants aim to capitalise on smart beta’s popularity. Labelling a product as smart beta is no guarantee of its investment efficacy. 

“Research demonstrates that only a few factor-based approaches are truly robust and able to deliver real returns outside of the back-test. Many factors have major implementation drawbacks or lack efficacy out of sample.”

But Joseph Molloy, global head of passive equities at HSBC Global Asset Management, notes levels of interest in all passive strategies continue to grow, driven by a greater focus on transparency, costs and understanding. 

“The main headwind for providers of passive products remains continued fee compression,” he adds. 

“However, the past 12 months has shifted away from price being front and central and towards a great focus on the value added proposition from passive managers as they are not all the same. Clients want a range of products that fit their needs, whether that’s traditional market cap or smart beta and factor strategies. 

“With a continued shift towards environmental, social and governance products, we’ll see increasing interest in products that allow a greater level of flexibility and customisation in the future.”

Looking ahead, however, technology could play a larger role in passive strategies both as a strategy and in implementation.

Lynn Hutchinson, assistant director at Charles Stanley, says: “Robotics and automation is being adopted across many if not all aspects of industry and day to day life. With a wide variety of ETFs available, it is no surprise that there are now passive products that track shares which produce or have some involvement in these type of companies.”

Mr Molloy adds: “Technology is going to play a bigger role in passive going forward. This is partly due to changes in regulation [Mifid II], which seek to ensure transparency, reporting and efficiency. 

“Investment teams will still remain key in portfolio construction and trade implementation, but the design of the technology platform, embedded into the investment process will be key differentials between the ever-growing number of new entrants in recent times.”

Nyree Stewart is features editor at Investment Adviser