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‘Smart Beta 2.0’ Goes Head to Head With Traditional Asset Managers

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Moody’s Investor Service noted in a comment last week that asset managers are accelerating their expansion into the smart beta space as alternative index strategies become more sophisticated and gain broader market acceptance.

According to Moody’s, two types of firms are well-positioned to capitalize on the growing popularity of smart beta.

One group comprises large asset managers — including BlackRock, State Street and Vanguard — that have scale and broad quantitative research and product distribution capabilities.

The second group is made up of model-focused and theme-oriented innovators that are prepared to take differentiated approaches, accessing nontraditional betas or generating true alpha.

In this latter group, firms such as AQR, DFA, Guggenheim, Research Affiliates and WisdomTree willingly take on performance risks associated with diverging from benchmark indexes.

They are also comfortable developing products with concentration risks and using market timing, factor rotation, factor timing and other techniques.

Moody’s pointed to several firms that have significantly invested in smart beta in the past year in the race to be top dog in the space:

  • OppenheimerFunds last week agreed to acquire smart-beta-focused VTL Associates
  • Vanguard just hired smart beta specialist Denis Chaves from Research Affiliates
  • BlackRock hired Columbia business professor Andrew Ang in June to lead its factor-based strategies group, and last week launched three multi-factor ETFs
  • Legg Mason recently acquired QS Investors
  • Nasdaq bought Dorsey Wright
  • Victory Capital acquired Compass EMP

In addition, Moody’s said, Franklin Templeton has been considering raising its flag in smart beta.

“We believe that capital investment into smart beta product development is likely to continue at a robust pace,” Moody’s said in the comment.

The comment noted that the accelerating activity had coincided with a shift in the evolution of smart beta products from simple and static security selection and weighting schemes to more sophisticated products based on multiple factors and timing of exposures.

Smart beta’s next phase, which Moody’s calls “smart beta 2.0,” will be more research intensive.

Moreover, Moody’s said, smart beta funds will likely compete directly with traditional mutual funds, given that future smart beta strategies will not only use multiple factors, but will also incorporate decision-making processes to determine and actively adjust a fund’s level of exposure to different factors and betas.

Smart beta 2.0 will try to achieve the goals of traditional active managers, it said, but at a lower cost and by more consistently adhering to a set of investing rules.

According to the comment, traditional active managers may be forced to further compete on price if smart beta’s growth persists.

Not only that, but asset bases could be at risk from managers who cannot differentiate themselves by performance or other services offered to clients.

Moody’s said traditional mutual funds with highly diversified portfolios whose performance closely tracked, and typically lagged, the index were most at risk.

“The AUM loss from these firms could directly accrue to asset managers well-positioned to offer the next iteration of smart beta funds,” it said.

— Check out S&P Smacks Down a Big Argument for Active Management on ThinkAdvisor.