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Strategic Beta Losing Its Luster: Morningstar

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Strategic beta may be past its prime.

According to a new report from Morningstar, more strategic beta exchange-traded products in the U.S. — primarily ETFs but also including exchange-traded notes (ETNs) — shuttered in 2019 than launched, and their performance during the first five months of this year was lackluster.

Thirty new strategic beta ETFs launched in the U.S. last year, 30% less than the year before and the lowest number since 2010, and 41 were closed. By year-end 2019, there were 639 U.S.-based ETPs with $960.6 billion in assets, and their market share, near 22%, was up just 1.2% from the prior year. Asset flows favored more traditional ETPs, according to Morningstar.

The performance of U.S. strategic beta ETPs, which account for 45% of the global number and 88% of the global assets, was also lackluster during the first five months of the year when  the COVID-19 pandemic took hold. Every strategic beta category except commodities on average underperformed its category index. 

Morningstar attributes the unimpressive performance to tilts toward smaller-cap stocks and lower valuations, which are most common in specific ETP category groups, namely dividend, fundamentals, multi-factor and value multi-factor and value groups. Small cap and value factors underperformed considerably during the first five months of the year.

But even within these categories there was a significant dispersion of returns. The Schwab U.S. Dividend Equity ETF (SCHD), for example, lost a modest 8.24%, while the Invesco S&P Ultra Dividend Revenue ETF (RDIV) lost more than three times as much (29.64%).

RDIV selects stocks solely based on dividend yield without using additional screens; SCHD focuses on both yield and quality, screening for stocks with strong dividend growth, cash flow/debt, return on equity and yield.  “The makeup of funds that are similarly labeled underscores the importance of thorough due diligence.” the report notes. “No two of these products are created equal” and the increasingly complex strategies of these ETPs increases the need for a clear understanding of their investment approach. 

Invesco is among the top three strategic beta ETP providers in the U.S., having 141 funds with $90.1 billion in assets and a 9.4% market share as of year-end 2019. iShares, with 64 funds and $382.4 billion in assets, is the number one ETP U.S. provider, with a 40% share, followed by Vanguard with 22 funds, $240.5 billion in assets and a 25% market share.

— Check out Here’s How Advisors Structure Their Model Portfolios on ThinkAdvisor.


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