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Portfolio > Mutual Funds

The Rise of Factor-Based Investing, aka Smart Beta, Finds Favor

By Melanie Waddell

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Factor investing “has been the epicenter of ETF product development,” said Ben Johnson, director of global ETF research for Morningstar, and is one of the main themes of Morningstar’s annual ETF conference, which kicked off September 7 in Chicago.

Last year, 109 strategic beta ETFs launched, hitting a “record clip,” Johnson said. Sixty-four strategic beta ETFs, which he says is synonymous with factor-based investing, have launched so far this year.

Charles Schwab Chief Investment Strategist Liz Ann Sonders frames the conference topics in her opening keynote to the more than 650 people attending the conference Wednesday through Friday. Sonders will discuss “where she sees things headed” in the U.S. and global economy—“the engine underlying all our investments,” said Johnson.

Other hot topics include portfolio construction and ETF managed portfolios, and the conference will also feature “newer” sessions on sustainability and impact investing, Johnson said.

Morningstar earlier this year released sustainability ratings for funds, allowing investors to evaluate funds based on environmental, social and governance (ESG) factors, he noted.

The ratings, first announced in August, relate to ESG metrics for approximately 20,000 funds globally, and allow investors to evaluate mutual funds and ETFs based on how well the companies held in the funds are managing their ESG risks and opportunities. 

Of the approximately 20,000 funds with Morningstar Sustainability Ratings, only 10% received a “high” rating.

(See Morningstar to Launch Analyst Ratings for ETFs.)

In a session at the conference, Johnson will reveal findings and highlights from two recently released Morningstar research reports: the semiannual “Active/Passive Barometer” study and Morningstar’s third-annual “Global Guide to Strategic-Beta Exchange-Traded Products.”

The Active/Passive Barometer found that actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons, and experienced higher mortality rates.

Compared to Morningstar’s mid-year 2015 report, active funds’ trailing one-year success rates deteriorated in 10 of the 12 categories examined during the 12-month period ending June 30, 2016. Morningstar observes:

  • Failure tends to be positively correlated with fees—i.e. higher-cost funds are more likely to underperform or be shuttered or merged away, and lower-cost funds are likelier to survive and enjoy greater odds of success.
  • Investors tend to pick better-performing funds, as evidenced by the fact that full category asset-weighted returns were generally higher than the equal-weighted returns. However, this isn’t the case within fee quartiles.

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See Factor Investing: A Post-Modern Portfolio Theory 

and visit the Morningstar ETF Investing Conference 2016 landing page for more ETF coverage.

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