Why Emerging Markets Deserve Another Look

So-called "smart beta" investments have both passive and actively managed characteristics. Where do these types of investments fit into an investor's portfolio?

That's what makes rules-based strategies so attractive; like active managers, they often express a research element/thesis, but then they have the relative cost efficiency of traditional passive products. We believe investors should implement smart beta strategies as they would any active solution — based on their intended goal or objective. Whether defined by a regional exposure, or by a series of discrete factors such as company profitability and dividend yield, smart beta funds give investors the flexibility to fine tune their portfolio construction process. These strategies work well as core exposures, as complements to active mandates, or satellites to broad passive benchmarks. In fact, we often find ourselves helping advisors build such differentiating portfolios.

Fees in the asset management business have been compressing. Do you think putting active management inside an ETF wrapper is the next big development?

Active ETFs are not a new development; they just haven't been widely received beyond a handful of products. There will likely be a continued effort to market more of them over time. That said, we believe smart beta in all types of wrappers — ETFs, mutual funds, SMAs, etc. — is more likely to be the next big development.

ETFs still have very low penetration in the retirement marketplace. Do you envision a day when ETFs will become more widely available inside 401(k) plans?

Absolutely. Investors clearly value the versatility, transparency and cost efficiency of the ETF wrapper and once the infrastructural work is universally performed to accommodate them, we will likely see an increase in ETF use in defined contribution plans. In the interim, however, we believe that smart beta strategies offered through mutual funds and other commingled retirement vehicles could satisfy growing investor interest.

What do you see ahead for the ETF industry?

There are no crystal balls, but we do note two areas of growing interest. First, at the product level, we're going to see a continued proliferation of distinctive smart beta strategies. With common client needs such as volatility management, steady income, and after-tax returns, asset managers will be encouraged to develop targeted products that try to tap into a spectrum of outcomes or of investment themes. It's an exciting time for product development.

Second, as a result of this greater product palette, we also note a growing opportunity for those who assemble them. The ETF strategist landscape has undergone some important roster changes during the last year and we believe that client demand remains high. Managers who have developed competitive outcome-oriented portfolios to address client investment objectives (beyond simple risk tolerances) will have a differentiated opening in the market. The increasing proliferation of smart beta funds will contribute to this trend and ETF strategists will be better equipped to create more distinctive investment solutions. In the end, better portfolio construction means an improved client experience — and that's the most important outcome of all.