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Smart beta rewards discerning devotees in 2022

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Smart beta strategies, which aim to outperform traditional broad market capitalisation-weighted indices by filtering them according to certain factors, delivered returns as high as 15 per cent last year even as major markets fell by a fifth.

Research by Scientific Beta, a factor-based data provider and consultancy, has found that value strategies — investing in global stocks deemed to be inexpensive — delivered returns of 11 per cent compared to losses of between 17 and 18 per cent for global cap-weighted indices such as the Scientific Beta Global Cap-Weighted index, FTSE All-World index and MSCI ACWI index.

Momentum strategies, which invest on the basis that asset prices that are already rising will rise further and falling ones will continue to fall, delivered even higher returns at 14 per cent for the year.

Low investment, defined by Scientific Beta as investing in stocks of firms with low investment (determined by change in total assets or book value), performed the best of all, delivering returns of 15 per cent.

Scientific Beta’s research, which focused on six factors: size, value, momentum, low volatility and two quality factors, namely high profitability and low investment, also found that low volatility had flat returns and high profitability had negative returns.

When all six factors were combined into a multi-factor approach, overall returns were 4.5 per cent for the year.

“2022 was a good year for multifactor strategies, but part of the good performance comes from the slightly defensive nature of these strategies,” said Felix Goltz, research director at Scientific Beta.

Smart or “strategic” beta exchange traded funds account for 16 per cent of all equity ETF assets in the US, according to CFRA, a data provider.

“They saw significant inflows in 2022,” said Aniket Ullal head of ETF data and analytics at CFRA. He said dividend and low volatility ETFs had taken in $68bn and $10.6bn respectively in net inflows during the year.

Ullal noted that more than half of filings to the US Securities and Exchange Commission for new ETFs in the final quarter of 2022 were for actively managed (ie non-indexed) ETFs.

“When these funds launch, they will need to compete primarily with ‘quasi-active’ smart beta ETFs for assets. The asset-gathering success of active relative to smart beta ETFs will be an important trend to watch in 2023,” Ullal said.

Todd Rosenbluth, head of research at VettaFi, said smart beta strategies had a “great year” in the US, “particularly dividend, lower volatility, value and equal weight”.

He said traditional market cap-weighted strategies tended to be tilted toward growth companies that struggled as interest rates climbed higher.

ETFGI, a consultancy, has recorded strong flows for smart beta strategies globally with net inflows of $124bn in the 11 months to the end of November last year, second only to 2021’s record haul of $127bn for the same period.

Nick Kalivas, head of factor and core equity product strategy for Invesco, a specialist in smart beta offerings, said he liked to remind clients about stock concentration.

At the end of 2014 the 10 largest companies in the S&P 500 in terms of market cap had a combined weighting of about 17.5 per cent, he said. By the end of 2021 that had risen to 30.5 per cent but by the end of last year it had fallen back to 25.5 per cent.

“What we tend to see is that when concentration falls, it’s good for smart beta,” Kalivas said, adding that the rising concentration between the end of 2017 and 2020, when 10 companies were responsible for half the S&P 500’s returns, explains why smart beta strategies began to disappoint.

However, despite the improved overall outlook, Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, said Europe, in particular, had been lacklustre, with value, for example, suffering net outflows in 2022.

“The truth is that strategic beta has never really set the heather alight in Europe in the same way as it has in the US. Strategic beta assets in Europe have sat below 9 per cent of total [exchange traded product] assets since 2016 while in the US they have hovered around 20 per cent of the total market over the same period,” Lamont said.

Overall though, and perhaps particularly with a view to US markets, analysts expect sustained interest in smart beta approaches.

“Looking ahead, given the uncertainty around inflation, rates and energy — driven by the Ukraine crisis — it seems reasonable to expect continued investor interest in dividend, low volatility and value smart beta strategies,” Ullal said.

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