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Jan 29, 2019

ETF providers turn to strategic beta strategies after market turmoil

Issuers developing more expensive beta strategies, says report

Exchange-traded fund (ETF) providers are turning to more expensive strategic beta and actively managed strategies after rapid industry growth froze last year with the end-of-year stock market turmoil.

More than half (57 percent) of ETF issuers highlight that they are developing strategic beta strategies – which use rules-based strategies that are not necessarily market-weighted – compared with 41 percent of issuers that report developing active ETFs and 36 percent that report developing passive ETFs, Boston-based consulting firm Cerulli Associates says in a report.

ETF assets grew at a compound annual rate of 21 percent during the five years through 2017 as investors flocked to low-cost, passive strategies, according to the report. But growth stagnated last year as equity markets deteriorated, leaving ETF providers to consider developing more expensive strategic beta and active funds.

Strategic beta strategies target exposure to stock characteristics such as growth or value, using a customized approach that aims to produce alpha.

‘The ETF industry has flourished by challenging market convention, particularly the necessity for expensive active management, by providing low-cost passive, transparent, liquid and tax-efficient investments in an easily accessible wrapper,’ comments Daniil Shapiro, Cerulli’s associate director, in a statement.

‘As issuers search for new drivers of growth, innovation can push trade-offs in the features that made ETFs successful products. Issuers will need to strategically assess the viability of ETF variations and whether or not they support the spirit of the ETF industry and provide value to investors.’

While Cerulli expects the ETF industry to continue to grow, it cautions against extrapolating from historical flows and market returns.

ETF issuers that are interested in generating higher fee revenues can offer strategies that fall outside of core allocations, with buyers willing to pay for more unique exposure and specialized strategies, notes the report.

ETF issuers are increasingly evaluating the viability of self-indexing – relying on one’s own index methodology – as an alternative to licensing indices via providers such as S&P Dow Jones, MSCI and FTSE Russell.

‘Self-indexing is also an opportunity for issuers to create unique products based on firm expertise and capabilities in the strategic beta, thematic and alternatives spaces, as well as a quicker and less expensive way to create bespoke products by client request,’ notes the report.