One of the most dramatic changes in the investment landscape over the past few years has been the rise in popularity of ETFs. Numerous factors are driving this change and the adoption of what is seen as an efficient, transparent and exciting product area focused on innovation and delivering the best solution from a client perspective.
In the US, advisers building ETF-only strategies have grown substantially and at the end of March 2016 managed total assets of $76bn from 156 firms.
In the UK, while not at the same level, there is considerable interest in adopting similar strategies based on ETFs. Part of this shift in adoption was driven by the retail distribution review and more recently by the advent of robo-advisers. In both cases the low cost, efficiency and breadth of asset choice and fund exposure have helped put ETFs at the forefront of investment opportunities.
The longer term trends of investors focusing on costs, returns, risk management and diversification suggest that the evolution away from traditional mutual funds to ETFs is definitive as opposed to fleeting.
An early part of the shift in assets and strategies has been centred on the transition by advisers to the increased use of passive funds. This has been driven by the lack of stability of alpha generation by active managers and a focus on pure market capitalisation index-based exposures in both the equity and fixed income space. While the shift to well-known and high-profile traditional indices, such as the FTSE 100, S&P 500 and MSCI Europe, has been well documented, the market has continued to evolve.
Over the past few years there has been a more nuanced focus on newer strategies that help solve the challenges of a low interest rate macro-economic environment and can help advisers build more solutions-based portfolios.
Typically, this trend has been epitomised by increasing use of smart beta indices, which tend to offer strategies that are different from pure market capitalisation exposures and aim to provide alternative outcomes. This means advisers can build different risk-based portfolios and achieve varying profiles that reflect investor preferences including income generation, global diversification, long-term enhanced risk-adjusted returns and multi-asset portfolios.
Smart beta has become an important tool in financial advisers' kit as ETF issuers focus on the key challenge, which is education. Once advisers have a thorough understanding of how differentiated smart beta ETFs tend to be from their plain vanilla market capitalisation weighted counterparts, the value proposition becomes clearer and more accessible.
Some of the most popular smart beta strategies today deliver powerful solutions to common investment challenges. At the forefront of advisers' minds have been key themes such as income generation, low volatility, risk management and asset class diversification.
In each case there are smart beta solutions that cannot be matched by market capitalisation-based funds or active strategies.
Smart beta is also increasingly gathering assets that would have historically gone to active managers and in these instances the focus is not just on low cost and efficiency. One of the most important aspects of smart beta ETFs that has truly caught the imagination of advisers is an understanding that they can offer similar exposure to active styles, but in a systematic and more risk controlled framework.
