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The smart-beta ETF revolution

Arian Neiron  |  25 Jan 2017Text size  Decrease  Increase  |  

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2016 will be remembered as a pivotal year that significantly changed the course of politics. It was also the year that smart-beta ETFs moved from the periphery of the investment management industry towards centre stage.

In 2017, smart-beta investing will continue to gain momentum.

Total flows into ASX-listed smart-beta ETFs reached $563 million, accounting for almost 20 per cent of the total Australian ETP industry flows of $3.06 billion  in 2016. Smart-beta ETFs attracted 60 per cent of total ETP inflows in December 2016 alone.

Ongoing market volatility in 2016 was a significant contributor to the growth of smart-beta investing.

Speculation leading up to the US election and a rise of anti-establishment and protectionism sentiments globally caused markets to rally considerably, encouraging investors to seek out ways to achieve targeted portfolio outcomes.

What is smart beta?

Smart-beta strategies offer investors the best of both worlds, aiming for outperformance like an active strategy while providing low-cost, transparent, and rules-based attributes of a passive strategy.

An example includes alternative weighting such as equal weight, while other more popular examples include factor and multi-factor strategies.

Factors in smart-beta strategies have been identified as persistent drivers of return that explain how securities behave. Examples of widely regarded factors are quality (financially strong companies) and value (inexpensive companies).

Smart-beta investing is demonstrating its worth at a time when scrutiny is increasingly being applied across the asset management industry. The most recent S&P Dow Jones SPIVA Australia Scorecard showed most Australian active funds underperformed their respective benchmark over one, three and five-year periods. As a result, investors are turning to smart-beta strategies.

Globally, smart-beta equity ETF/ETPs globally reached a new record of US$497 billion , across 1,179 smart-beta equity ETFs/ETPs.

Locally, smart-beta ETFs account for 20 per cent of ETPs listed on the ASX and we expect innovation to continue to offer investors the best of both active and passive management.

Two examples of outperformance by smart-beta ETFs on ASX:

US equity: VanEck Vectors Morningstar Wide Moat ETF

The S&P 500 surged at the end of 2016 after positive response to Trump's proposed policies on industry deregulation and his campaign theme of expansionary fiscal policy.

On the ASX there are a number of ETFs that provide investors with direct access to US equities but most track traditional indices such as the S&P 500.

The VanEck Vectors Morningstar Wide Moat ETF (ASX: MOAT) is a smart-beta US equity ETF which provides exposure to at least 40 financially strong US companies based on the most compelling valuations.

MOAT tracks the Morningstar Wide Moat Focus Index, which is rules-based and equally weighted.

The "wide-moat" philosophy identifies companies with structural competitive advantages that are expected to allow them to earn above-average returns on capital over a sustained period of 20-plus years.

MOAT outperformed the S&P 500 Index by 9.82 per cent, returning 22.31 per cent in 2016.

Australian equity: VanEck Vectors Australian Equal Weight ETF

There is a lot of academic research that supports equally weighting securities in a portfolio to derive long-term outperformance.

Equal weighting provides exposure away from mega and large caps and provides exposure to value (inexpensive stocks) and contra trading strategies (frequently taking profits from winners and adding to losers at prescribed intervals to maintain equal weighting).

The Australian equity market is one of the most concentrated equity markets in the developed world. The standard benchmark, the S&P/ASX 200, is the most commonly used market capitalisation index by Australian equity active managers.

However, the index is dominated by the top 10 companies, which comprise of over 55 per cent of the index, including the big four banks.

The VanEck Vectors Australian Equal Weight ETF (ASX: MVW) tracks the MVIS Australia Equal Weight Index, which offers higher exposure to stocks outside the top 10, ensuring that no one company or sector dominates.

In 2016, VanEck's Australian Equal Weight ETF returned 18.16 per cent, outperforming the S&P/ASX 200 Index by 6.37 per cent. Since its launch in March 2014 it has outperformed the S&P/ASX 200 Index by 4.30 per cent per annum. The index MVW tracks has now outperformed in 11 of the past 14 calendar years.

VanEck's Equal Weight strategy ranked eighth out of 96 "long-only" Australian equity funds in Mercer's annual fund manager league table in 2016.

112 months to December 2016, ASX Fund Monthly Update--December 2016

2 According to data from ETFGI's November 2016 global smart beta equity industry insights report

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Arian Neiron is the managing director of VanEck Australia. VanEck is a leading global provider of exchange-traded funds (ETFs). This is a financial news article to be used for non-commercial purposes and is not intended to provide personal financial advice to any person.

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