From the June 2014 issue of Research Magazine • Subscribe!

Getting Smart Beta

Despite strong disagreement on Wall Street about the “smart beta” moniker, the adoption rate among institutional investors for these types of strategies is expected to jump.

A newly released report titled “Smart Beta: A Deeper Look at Asset Owner Perceptions,” by Russell Investments found that 88% of institutional investors from North America and Europe with more than $10 billion under management have evaluated smart beta strategies or plan to do so in the next 18 months. Furthermore, 76% expect to make a portfolio allocation to smart beta.

Smart beta is used to describe indexes that use rules-based stock picking and alternative weighting methods.

“Our survey confirms that we’ve clearly reached a new stage in the evolution of investment management,” said Rolf Agather, managing director of global index research and innovation for Russell Investments. “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.”

What were among the top reasons for institutional investors embracing this alternative strategy?

Reducing risk and enhancing returns ranked at the top of the list of investment objectives that moved respondents’ analysis of smart beta strategies, with over 60% of institutional investors attributing their evaluation to each of these two investment objectives. Controlling factor exposures was among the greatest unmet needs by smart beta indices cited by surveyed participants.

Agather added: “Effectively integrating smart beta strategies within a broader portfolio requires that an asset owner maintain standards of assessment and ongoing review similar to those associated with any active strategy. The results of our survey underscore that asset owners’ growing interest in and adoption of smart beta strategies has driven the need for additional information, education and advice.”

In the U.S. and the U.K., institutional investors were most interested in fundamentally weighted index strategies, while in Canada and Europe ex-U.K., volatility-control indexes were most popular.

ETFs that follow a rules-based approach to selecting and weighting stocks include the PowerShares FTSE RAFI 1000 (PRF), Direxion S&P 500 DRRC Index Volatility Response Shares (VSPY), and the First Trust Asia Pacific ex-Japan AlphaDEX Fund (FPA).

Cutting investment costs by using smart beta as a replacement for other investment strategies ranked at the bottom of the list, with just 15% citing this as important.

Finally, there was no consensus agreement on the smart beta name or even an official definition. In North America, 33% of respondents preferred “alternatively weighted indexes” to refer to this type of investing while 35% in Europe embraced “smart beta.”

The Russell study surveyed nearly 200 equity investment decision makers across a broad spectrum of pension plans, endowments and foundations of different asset sizes and regions. The goal of the survey was to gain a better understanding of the perceptions and levels of adoption of smart beta strategies within institutional ranks.

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