Investor Interest in and Requirements for Smart Beta ETFs

Felix Goltz, Véronique Le Sourd: Exchange-traded funds (ETFs) are perhaps one of the greatest financial innovations of recent years.

Author(s):

Felix Goltz

Head of Applied Research at EDHEC-Risk Institute.

Veronique Le Sourd

Senior Research Engineer at EDHEC-Risk Institute.

Unlike conventional index funds, ETF units trade on stock exchanges at market-determined prices, thereby combining the advantages of mutual funds and common stocks. Most of them represent passive instruments designed to track the performance of a financial index as closely as possible. Recently, the standard practice of using a capitalisationweighting scheme for the construction of indices has been the target of harsh criticism. Nowadays, growing demand for indices as investment vehicles has led to innovations including new weighting schemes and alternative definitions of sub-segments. There are many recent initiatives for non cap-weighted ETFs as well. Since the first fundamental factor-weighted ETF launched in May 2000, there have been quite a number of ETFs introduced to track nonmarket cap-weighted indices, including equal-weighted ETFs, minimum variance ETFs and characteristics-weighted ETFs. These have been coined “Smart Beta ETFs” as they seek to generate superior riskadjusted returns compared to standard market capitalisation-based indices. Alternative equity beta investing has received increasing attention in the industry recently. Though products in this segment currently represent only a fraction of overall assets, there has been tremendous growth in terms of both assets under management and new product development. At the end of August 2014, according to ETFGI, 15% of assets in equity ETFs or ETF-like products were in products tracking “Smart Beta” indices and assets invested in smart beta ETFs or ETF-like products have been increasing at a 5-year compounded annual growth rate of 36.1%, compared with a 5-year compounded annual growth rate of 17.8% for assets invested in cap-weighted ETFs or ETF-like products. Moreover, a study from Cogent Research reveals that about half of institutional investors will increase their investment in smart beta ETFs in years to come.

Type: EDHEC Publication
Date: le 06/04/2015
Research Cluster : Finance

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