Smart Beta Gaining Traction Among Institutional Investors

Current allocations are small, but more than half expect to increase it, Russell says

More institutional investors are considering smart-beta strategies. More institutional investors are considering smart-beta strategies.

Institutional investors, especially those managing more than $10 billion, are increasingly adopting smart beta strategies, according to a report released Monday by Russell Investments. Almost a third of respondents said they currently have smart-beta allocations. Of those, 53% say they will increase that allocation. Just 5% expect to decrease it.

Most investors have a relatively small smart beta allocation. Forty percent have less than 5% of their equity portfolio invested in a smart beta strategy, and 22% have between 6% and 10%.

Russell surveyed nearly 200 equity investment decision makers in the first quarter for the report, with respondents from pension plans, endowments and foundations of different asset sizes, regions and in different stages of their evaluation and adoption of smart beta.

Among the largest investors, 88% have considered a smart-beta strategy or plan to do so in the next 18 months. Half of investors with under $1 billion and 77% of those with between $1 billion and $10 billion agreed.

Furthermore, of those who are considering whether to add smart beta, more than three-quarters expect that they will.

As for their motivations, risk reduction and return enhancement were the top two reasons given by investors who were evaluating smart-beta strategies.

“Our survey confirms that we’ve clearly reached a new stage in the evolution of investment management," Rolf Agather, managing director of global index research and innovation for Russell Investments, said in a statement. "Smart beta indexes and investment strategies are gaining traction among asset owners because these highly sophisticated investors are finding value in their investment outcomes and characteristics.”

Approximately 20% of respondents said they had no plans to evaluate smart beta in the near future, and most believe the strategy doesn’t merit consideration. Nearly a quarter said they didn’t have the resources to make an evaluation, and 21% just don’t believe in passive allocations. Just 3% said they didn’t have enough assets under management to justify smart beta.

For some investors, smart beta is just too new. More than a third of respondents who decided against a smart-beta allocation said it was because it had a limited track record. Even so, 88% said they would consider a strategy later.

Asked to choose from possible definitions, nearly half of respondents (45%) agreed that “alternative ways to construct market exposures such as minimum variance, fundamental weighting, maximum diversification, equal risk or equal weighted” was the best definition. However, others agreed on broader definitions that emphasize the strategies’ non-market-cap weighting (22%) or “transparent, rules-based” approach that provides exposure to specific markets or factors (22%).

The survey found some disagreement in what investors actually call these strategies. North Americans and the smallest investors preferred “alternatively weighted indexes” to refer to those strategies. Those in Europe, where adoption is strongest, and the largest investors preferred “smart beta.”

For additional reporting on smart beta and its role in portfolios, see Investment Advisor's April 2014 cover story, featuring Rob Arnott.

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