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More Big Investors Embracing Smart Beta, ESG: Study

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Smart beta, otherwise known as strategic beta or factor investing, continues to catch on with institutional investors, with implementation of these strategies rising 10% in the last year to 58% of those surveyed by global index provider FTSE Russell in its sixth annual study on the topic. That number jumps to 78% when also counting those who are evaluating or plan to evaluate smart beta strategies for their investments.

The study also revealed a shift in how asset owners view smart beta, according to Rolf Agather, FTSE Russell’s managing director of research for North America, who said in the report, “Across all regions and AUM tiers, asset owners view smart beta allocations as more similar to traditional active strategies, and less aligned with traditional passive strategies.”

He noted that concern about taking on additional risk was one of the barriers to adopting these strategies, a worry that grew since the previous year, thus managers “acknowledge the active risk associated with smart beta.”

The survey of 178 global asset managers was conducted in January and February, with almost half of respondents (46%) coming from North America, 29% in Europe and 19% in the Asia Pacific.

The trend in multi-factor strategies was strong in 2019, Agather wrote, accounting for 71% of adoptions, while 69% of those who implemented smart beta strategies in past two years used multi-factor methods. The next highest factor used was low volatility at 35% and value at 28%.

The three top reasons asset managers use smart beta were risk reduction, return enhancement and improved diversification, according to the study. Cost savings was fourth (31%), “suggesting that smart beta is increasingly being used in place of more expensive active strategies,” Agather said.

Just over half (52%) were satisfied or very satisfied with the strategy, the study found. However, a large majority, 61%, of asset owners with smart beta allocations rely on external managers for information. Further, allocations were strategic in nature and separate accounts were the preferred vehicles, FTSE Russell found.

How ESG Fits In

The study also looked at how managers include environmental, social and governance investing within portfolios, and found that 40% of them were looking to apply ESG considerations to the smart beta strategy. FTSE Russell calls this integration “smart sustainability,” which applies a “consistent factor methodology across both risk premia factors and ESG parameters.”

The largest interest in ESG factor investing is in Europe, where 77% of asset owners wanted to apply ESG — this is up from 55% last year, and may have to do with new European regulations.

The opposite is true in the United States, in which only 17% of owners indicated a similar interest, down from 25% last year. This might be due, the study states, to the Trump administration’s “recent interventions,” especially pertaining to pension plans.

Most of those who indicated an interest stated “long-term risk mitigation” as the most popular response, 78% in 2019 versus 54% last year.

At this point, 60% typically use ESG data for negative screening, although those with $10 billion or more in assets under management “are likely to go beyond screening and use ESG data akin to factors within the re-weighting methodology.” This compares to only 26% of smaller asset owners, the study states.

Usage of ESG and smart beta promises to grow, however, as the study found 58% of larger funds and 30% of smaller funds plan to increase allocations. Those who plan to add ESG smart sustainability strategies broke down their key issues going forward into 74% governance, 66% carbon and 64% social.

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