Nizam Hamid, head of strategy at WisdomTree Europe, analyses what increasing flows to smart beta ETFs mean for the industry over the next four years.
The ETF industry has once again seen a huge uptick in assets under management recently, despite the negative impact of weak stock markets.
According to statistics from the Investment Association, trackers in the UK accounted for 12.4% of all retail assets by the end of 2015, a 16% increase from 2014*. Net retail sales also hit a record high of £5.4bn.
Globally passive funds have grown four times faster than active products since 2007, according to the latest study by Morningstar, with assets in passives now standing at approximately $6trn.
There is a long way to go of course, especially in Europe where ETFs account for just 3.7% of assets held in mutual funds. That figure is far below the US where they account for almost 17%, but this in itself presents an opportunity as there is clearly scope for European investors to add ETFs, either to gain core or satellite exposure to various asset classes.
Smart beta is finding itself, more and more, front and centre when it comes to ETF usage.
At the halfway mark in 2016, 40% of total flows into European ETFs have gone into smart beta products, as investors become more sophisticated and look for more specific solutions rather than simply allocating to whole markets.
An even more compelling statistic is that whilst European market capitalisation ETFs suffered outflows of $9.1bn in the first half of this year, smart beta and alternatively weighted strategies had net inflows of $5.7bn.
This continues a trend seen last year, with Morningstar Direct data revealing smart beta equity ETFs listed globally gathered $77bn for the whole of 2015, taking total assets in the products to $486bn.
Where does this take us over the next few years? If this current level of growth was maintained, it means the industry would push past $500bn by the end of 2016, and reach almost $800bn by 2020.
However, I expect the figure will actually be a lot nearer to $1trn by the end of the decade, mainly because of two powerful trends: the desire for tailored ETFs and for low-cost alternatives to active funds – are now firmly in play.
Investors are cottoning on to the idea that, rather than weighting by market cap and simply having large positons in the biggest stocks regardless of their underlying performance, it makes more sense to screen much more actively. Creating a tailored index based on a specific set of rules can, over time, capture positive market trends, and if such solutions can outperform market cap indices (while costing less than active funds) it should help boost growth substantially.
This shift in thinking among ETF investors should not be underestimated, especially as investors continue to look more at outcomes and long-term goals.
As ever, there also remains a case for using lower cost alternatives to active funds. That debate is not going anywhere, especially as fees on active funds are only ever going to fall at a snail’s pace, if at all.
Smart beta solutions priced well below active equivalents will continue to benefit from this alongside the wider passive industry, especially given the cost-conscious environment we find ourselves in.
Clearly, these solutions will not suit everyone, but if the strategies can do their part by continuing to deliver returns ahead of mainstream ETFs (and rival returns produced by active funds) the sky is the limit in terms of AUM growth.
*According to the Investment Association’s most recent update, entitled ‘FUNDS UNDER MANAGEMENT UP £36 BILLION IN 2015’ (published on 25 January 2016). http://www.theinvestmentassociation.org/media-centre/press-releases/2016/press-release-statistics1215.html