When People’s United Bank announced late last week that it was acquiring Gerstein Fisher, a $3 billion New York City-based boutique investment management firm, it joined a growing number of financial institutions buying up smart beta money managers.
(Related on ThinkAdvisor: Hartford Funds to Buy Smart Beta Firm Lattice Strategies)
Earlier this year, Hartford Funds bought Lattice Strategies, Columbia Threadneedle acquired Emerging Global Advisors and JPMorgan Chase bought a minority stake in Global X Management. Last year, Victory Capital bought Compass Efficient, Legg Mason acquired QS Investors and OppenheimerFunds purchased VTL Associates.
(Related on ThinkAdvisor: Columbia Threadneedle Moves Into Expanding Smart Beta Field)
It’s a trend that is expected to continue as asset managers try to expand their repertoire beyond traditional management in order to compete against the three big institutional money managers: BlackRock, Vanguard and State Street.
These acquisitions provide traditional asset managers access to one of the hottest investment strategies around, which is a cross between relatively expensive actively managed strategies and cheaper passive cap-weighted index strategies. Many, but not all, are acquisitions of firms with smart beta ETFs.
Those ETFs are a way for “bigger firms to build out their ETF strategy and move from active management where demand is declining, toward cheaper passive investing,” says Jennifer Muzerall, associate director at Cerulli Associates. “The way of the world is a move toward passive investing.”
At the same time, smart beta ETFs provide big investment firms a product that can potentially outperform traditional passive market-weighted indexed ETFs and charge higher fees than traditional market-weighted indexed ETFs.
Smart beta has become a catchall phrase for a variety of alternative index strategies that focus on specific factors, such as low volatility, dividends, momentum and cash flow that are used to screen stocks.
One of the hottest smart beta categories is the multi-factor approach, which is what Gerstein Fisher employs. The firm’s quantitative multi-factor approach used for a focuses on 10 factors including price (favoring value stocks over growth even among growth), momentum (of rising stock prices), size (favoring small over large even in the large-cap category), leverage, capital expenditures and research and development. Two of three of its multi-factor mutual funds are rated five stars by Morningstar, and one has a four-star rating.
According to Morningstar, there were 603 strategic beta exchange-traded products, with assets totaling $487 billion as of June 30, and they accounted for 22% of all ETPs (“strategic beta” is Morningstar’s term for smart beta and ETPs include ETFs plus exchange-traded notes).
The proliferation of these funds, though primarily a benefit for the firms that have created them or acquired them, is also a positive for financial advisors, because they provide advisors:
- More choices of a relatively low-cost investment alternative to actively managed funds
- A potentially more stable investment product over time because the rule-based mechanical processes of these ETFs leave little room for the whims – and mistakes – of human managers
- Potentially cheaper investment products because “it’s only a matter of time before so much product hits the market that fees are squeezed on these products as well,” says Muzerall.
But despite these benefits, the jury is still out on the performance of smart beta ETFs because most haven’t been around long enough to have a track record that advisors – and investors – can turn to, says Ben Johnson, Morningstar’s director of Global ETF Research.
Advisors can access some performance data through Morningstar’s Institutional Advisor program, direct data feeds or through Morningstar Advisor software package or Advisor Workstation. “Some strategies will do well; some less well,” says Johnson. “Investors will have to wait and see how they perform.”
In the meantime the three most popular strategic beta strategies now are multi-factor, dividend-oriented and low volatility, says Johnson. He notes that the multi-factor approach makes sense from a diversification point of view – some components zig while others zag, which improve the odds of better performance – and as a core portfolio building block.
But he cautions that advisors should not overpay for strategic beta ETFs. Any funds charging more than 30 to 40 basis points “should be viewed with a heavy dose of skepticism,” says Johnson.
Muzerall cautions that advisors need to understand the methodology of smart beta ETFs, or mutual funds, before they invest their clients’ money in those products.
“Being able to understand the transparency of the investment strategy and what it seeks to do over different market cycles is very important,” says Muzerall. “There are instances where managers are taking a black box approach that can be more complicated as they try to differentiate themselves.” And that is the opposite of being transparent.
— Related on ThinkAdvisor:
- Use of Alts, Smart Beta Up
- Smart Beta Indexes Are Everywhere Now
- Columbia Threadneedle Moves Into Expanding Smart Beta Field
- Hartford Funds to Buy Smart Beta Firm Lattice Strategies
- Smart Beta Strategy Is Ripe for a ‘Crash’: Research Affiliates