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Indexers See Further Growth for Smart-Beta ETF Strategies

editor@etftrends.com (ETF Trends)

Smart-beta or alternative index-based exchange traded funds have quickly attracted the investment community’s attention and may act as major pillar of growth for the ETF industry ahead.

“Every index provider understands that this will be the future,” Raman Aylur Subramanian, MSCI’s head of index applied research, told ETF Trends. “It will be factor-based investing.”

Smart-beta ETF adoption has been gaining momentum among retail investors, financial advisors and even institutional investors. Retail investors and financial advisors have contributed to the first leg of the ETF industry’s growth spurt, and institutional investors could support ETF growth ahead.

“We do have too many ETFs but Indexing can get more creative. We need to find the right balance.” Ron Bundy, CEO Benchmarks North America of FTSE Russell, told ETF Trends in a call. “There’s a space for artificial intelligence in indexing but it really is active management, just not directed by humans. If its rules based and you can be transparent, it can be indexed.”

According to a recent FTSE Russell smart beta survey, global institutional asset owners currently evaluating smart beta have doubled to 36% in 2016 from 15% at the first survey in 2014, and 62% of asset owners with an existing smart beta position are now considering additional allocations.

Related: ETFs Gain Ground as Advisors Look to Passive Beta-Index Strategies

Close to 70% of asset owners also take a long view on smart beta, planning to utilize smart-beta options five years or longer to achieve their long-term investment objectives. The rising adoption reflects asset owners’ preference for return enhancement and risk reduction.

The smart beta survey of global asset owners also revealed a developing trend in asset owners’ views and usage of smart beta strategies. The percentage of asset owners that tracking five or more smart beta indices have increased significantly to 21% in 2016 from 2% in 2014.

Due to the increased usage of smart-beta strategies, we are also witnessing traditional open-end active fund managers tiptoe into the ETF industry with smart-beta options of their own.

“Smart beta strategies are active management’s response to smart beta ETFs; it’s the only way for them to enter the space,” Rolf Agathar, Managing Director of North American Research at FTSE Russell, told ETF Trends in a call.

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Among the most recent smart-beta innovations, index-based ETFs have integrated ESG principles, or companies that adhere to environmental, social and governance practices. For example, Columbia Threadneedle Investments recently launched the Columbia Sustainable U.S. Equity Income ETF (ESGS) , Columbia Sustainable International Equity Income ETF (ESGN) and Columbia Sustainable Global Equity Income ETF (ESGW) , which are based off customized MSCI indices.

Investing in ESG principles is a good way to help manage portfolio risks. Academic research revealed that strong governance mechanisms have helped diminish default risk and lower bond yields. Barclays also recently discovered that investment-grade bonds with higher ESG scores outperformed those with low ESG scores over the past 8 years.

Subramanian pointed out that sovereign funds, institutional investors and millennials have shown interest for the new breed of smart-beta strategies like those that track ESG principles.

For instance, the SPDR MSCI ACWI Low Carbon Target ETF (LOWC) and the  iShares MSCI ACWI Low Carbon Target ETF (CRBN) , which include ESG screens, were created for the United Nations Joint Staff Pension Fund.

Related: Institutional Investors to Support ETF Industry Growth

Global pensions and institutional investors have been shifting toward more socially responsible investments, diminishing their exposure to the energy sector in favor of more sustainable opportunities.

Moreover, millennials who may have a more green mindset have also been known to align personal beliefs with investment objectives, which could support ESG and socially responsible investment themes.

Alternative fixed-income strategies are also beginning to attract greater attention.

“Income-oriented indexing is in demand,” David Blitzer, Managing Director and Chairman at S&P Dow Jones Indices, told ETF Trends. “There is an appetite for more income solutions and we’re seeing it with fund flows globally.”

According to State Street Global Advisors data, fixed-income ETFs have taken in assets at a record setting pace this year, amassing $25 billion more by June compared to the same period last year. After attracting $8 billion in June, bond ETFs now outpaced equity funds by $50 billion in inflows year-to-date.

For more information on index-based ETFs, visit our indexing category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.