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Smart beta: 2015 survey findings from U.S. financial advisors

Factor-based and alternatively-weighted indexes have transformed the current investment landscape. These indexes, generically called “smart beta indexes” are weighted differently than traditional market-value or capitalization-weighted indexes, providing new tools to help tailor exposures to specific risk and return objectives. For the purpose of this study we will use the term “smart beta” or “smart beta products” to refer to an investable product such as a mutual fund or ETF that closely tracks one of these indexes.

Advisors have taken note and have increasingly embraced smart beta as a way of incorporating new ideas within their clients’ portfolios. But more choice and flexibility carries with it a need for more education. FTSE Russell conducted this survey of advisors as part of its ongoing educational program. The results are intended to establish a baseline assessment of current perceptions and levels of adoption of smart beta in the advisor community.

There is still some confusion about the definition of smart beta and the distinction between active and passive investing. The survey reveals that some advisors consider smart beta as a kind of active management. While the selection of a smart beta product for a client can require almost as much due diligence as selecting an active manager, it is important to keep in mind that the underlying smart beta index is transparent and rules-based; there is no active decision as to what securities are included or excluded within the index.

It is interesting to compare advisors’ perceptions on smart beta with results from our previous surveys of institutional asset owners. Advisors’ top two smart beta products are Dividend/Income Yield and High Quality. For institutional asset owners, the top smart beta product has been Low Volatility for two years in a row, with either Fundamental or Multifactor being the second. The contrast reflects the differing needs of advisors’ clients versus the needs of institutional asset owners. A similarity is that both advisors and asset owners are keen to explore multifactor index products.

This survey also demonstrates that more than two-thirds of the advisors surveyed are currently using a variety of smart beta products in their practices. Yet, with less than one in five advisors reporting that they are very familiar with the term “smart beta,” it is evident that smart beta education is still needed. Providers of indexes and smart beta products, including exchange traded funds (ETFs), need to ramp up their educational programs focused on the advisor community. Hopefully, this survey provides a useful perspective for all market participants.

Rolf Agather, CFA

Managing Director of Research, North America

Summary of key themes

Defining “smart beta,” and what is classified as smart beta, continues to be a point of confusion for financial advisors, even among users of smart beta products.

  • Without the help of descriptive prompts or product examples, 35% of advisors reported having used a smart beta product. Prompted by specific smart beta product names, more than two-thirds of advisors identified themselves as users of smart beta.
  • Upon seeing examples of smart beta products, 89% of non-users of smart beta expressed an interest in using them.

Education about smart beta is still important.

  • While 65% of advisors had heard the term “smart beta” prior to taking part in this research, only 18% reported that they are “very familiar” with smart beta.
  • Lack of knowledge is one of the top reasons advisors cite for not using smart beta products.

Advisors view smart beta products similarly to the way they view actively managed products.

  • Advisors have an interest in using smart beta to protect portfolios in down markets, control volatility and increase alpha.
  • Significant numbers of advisors are using the term “active” to describe smart beta.

Among existing smart beta investment approaches, Dividend and High Quality have the most advisor usage and interest.

  • Of all smart beta investment approaches tested, advisors are most likely to be using a smart beta approach that weights companies by their historical dividend yield, with 36% using this type of smart beta product and 35% interested in using it.
  • A High Quality investment approach shows the most potential for use, with 27% of advisors currently using it and 40% very likely to use it in the future.
  • More than 70% of financial advisors who are using smart beta are using more than one type of smart beta investment approach.

The smart beta user profile has several notable characteristics.

  • Advisors who use smart beta are more likely to be younger and to have a higher share of AUM in ETFs and alternative investments.
  • Advisors who use smart beta are more likely to have practices that extend beyond the core activities of investment selection, asset allocation and financial planning.
  • Smart beta users are more likely to view smart beta as a form of active management, and they are more receptive to newer forms of smart beta.

RIAs are more familiar with smart beta and more likely to identify as being users of smart beta products.

  • Registered investment advisors (RIAs) are more likely than regional, independent and wirehouse advisors to know the term “smart beta.”
  • Forty-six percent of RIA advisors provided unaided affirmation of smart beta product usage, compared with an average of 32% of other advisors.

Survey background

This survey tests smart beta awareness and interest among a select population of experienced advisors. To be eligible to participate in the study, advisors met the following criteria:

  • Have AUM greater than $20 million
  • Have at least 4% of AUM invested in ETFs
  • Have at least 20% fee-based annual revenue

These requirements were put in place to generate a sample from among advisors who were likely to be actively managing portfolios, rather than simply selling investments on a commission basis.

The screening criteria were intended to provide a detailed look at advisors who are likely to give thoughtful consideration to the role of smart beta within client portfolios.

FTSE Russell partnered with Greenwald & Associates to execute this research on smart beta perception and usage among financial advisors. The research was conducted in June 2015 and all results presented here are based on FTSE Russell analysis of responses from 307 financial advisors. Respondents were drawn primarily from wirehouses (29%), regional broker-dealers (23%), RIAs (23%) and independent broker-dealers (21%).

Ninety-nine percent of respondents had more than five years of financial advisor experience and 84% had more than 10 years of experience. By AUM, 81% manage more than $50 million and 52% manage more than $100 million. Full detail on the sample demographics can be found in the appendix.

Based on the count of advisors not selected due to screening criteria, we estimate that the target population for this study (as determined by AUM, percentage of AUM invested in ETFs, and percentage of fee-based annual revenue) represents approximately 40% of the total financial advisor universe.

Throughout the report, percentages may not equal 100, because of rounding, and/or because some questions allowed multiple responses. Questions with multiple responses are noted in each chart footer.

Defining “smart beta,” and what is classified as smart beta, continues to be a point of confusion for financial advisors, even among users of smart beta products.

Many advisors currently using smart beta don’t identify with the term “smart beta.”

As described in the survey background, the financial advisors included in this study were selected on the basis of their likelihood to give thoughtful consideration to the role of smart beta in a portfolio, as suggested by their AUM, percentage of AUM invested in ETFs, and percentage of fee-based annual revenue. Without the help of advisors in the sample (unaided users) reported having used a smart beta product. However, prompted by a definition and specific smart beta investment approaches, more than two-thirds of advisors in the study (aided users) identified themselves as smart beta users.

Upon seeing examples of smart beta, 89% of non-users expressed interest in using a smart beta product if a major investment firm offered it.

Despite not being familiar with or identifying with the term “smart beta,” a significant number of advisors in the survey expressed interest in considering smart beta after learning more about the kinds of products that would be considered smart beta. After learning the definitions of smart beta and seeing examples, 89% of non-users of smart beta expressed interest in using a smart beta product if it was offered by a major investment firm, with 28% saying they were “very interested” in smart beta.

Education about smart beta is still important.

Among advisors not using smart beta, lack of familiarity is a primary obstacle to usage.

Within the advisory community, education about smart beta is needed. While 65% of participating advisors had heard the term “smart beta” prior to taking part in this research, only 18% reported that they were “very familiar” with smart beta products.

Lack of knowledge is one of the top reasons advisors cite for not using smart beta.

“Not knowing enough about smart beta” is cited by 42% of respondents as a “very important” reason for not using smart beta in their practices; 35% of respondents cite “not having a long enough track record.”

 

Advisors view smart beta products similarly to the way they view actively managed products.

Protecting portfolio assets is top of mind for advisors, and several findings suggest that advisors may view smart beta as being a form of active management.

Advisors have an interest in using smart beta to protect portfolios in down markets, control volatility and increase alpha. Their primary reasons for using a smart beta product are similar to the motivations driving use of actively managed funds. In contrast, advisors choose passive index funds primarily for their low cost. Cost is less of a driving factor in the selection of a smart beta product.

When it comes to selecting a smart beta product, performance history is a key driver.

Aside from availability on the advisor’s platform, the strongest factor in choosing a smart beta product is its performance history in good and bad markets. Seventy-three percent of advisors point to performance history over the long term as being a very important factor in deciding which smart beta product to use, while slightly less than half say cost is a very important factor.

A significant number of advisors are using the term “active” to describe smart beta products.

A small but significant number of advisors use the term “active” to describe smart beta products. When asked about descriptive terms other than “smart beta”, advisors’ most common response, aside from the name of a specific smart beta investment approach was either “actively managed” or “active indexing.” This was offered by 15% of respondents. Among those advisors who wrote in a specific smart beta investment approach, the most commonly mentioned were equal weighting, fundamental weighting and factor weighting.

Findings suggest that compared to non-users of smart beta, users of smart beta1 are more likely to view smart beta as a form of active management. Relative to non-users, smart beta users are more likely to describe smart beta as “actively managed” (18% vs. 5%) and to feel that “increasing alpha” (95% vs.83%) and “high Sharpe ratios” (76% vs. 59%) are at least somewhat motivating reasons for using smart beta. Smart beta users are also more likely to see smart beta fitting in small cap (39% vs. 25%), an asset class typically associated with active management.

Among existing smart beta investment approaches, Dividend and High Quality have the most advisor usage and interest.

Of the existing smart beta investment approaches tested, Dividend and High Quality show the most potential for use in the marketplace.

Of the existing smart beta investment approaches tested, an index strategy that weights companies by their historical dividend yields is currently the most used by advisors; 36% of respondents are using this strategy, and 35% are interested in using it. A High Quality investment approach shows the most potential for use, with 27% of advisors currently using it and 40% very likely to use it in the future. Roughly half either use or are very likely to use a Fundamental, Low Volatility or Equal Weight investment approaches. Somewhat fewer either use (17%) or are very likely to use (24%) a Momentum approach that picks companies that have consistently exhibited strong performance over the prior 12 months.

For High Quality, Fundamental, Low Volatility and Momentum, the number of advisors who said they were very likely to use the investment approach in the future exceeded the number already using. For Dividend/Income Yield and Equal Weight, the number of advisors who are likely to use the investment approach in the future was roughly the same as the number of those currently using it.

Among emerging smart beta investment approaches tested, advisors showed the most interest in a multifactor approach.

Among new smart beta investment approaches tested, a multifactor (or Factor Combination) strategy shows the most potential for adoption, with 37% of advisors saying they would be very likely to use this approach, which combines multiple factors such as Low Volatility, Quality and Value. A somewhat lower percentage of advisors would be very likely to use a Dividend-Weighted Currency Hedge. Fewer advisors say they are very likely to use a Fixed Income smart beta product (23%) or a GDP Weighted smart beta product (18%).

Advisors who are currently using smart beta are more receptive to newer smart beta approaches.

Compared to those who have not used smart beta products, smart beta users are significantly more receptive to each of the newer investment approaches tested. Fifty-five percent of current smart beta users2 are either already using or very likely to use multifactor or Factor Combinations, compared to 31% of non-users of smart beta. Similarly, current smart beta users are more receptive than non-users to Dividend-Weighted Currency Hedge (53% vs. 18%), Fixed Income (41% vs. 19%) and GDP Weighted (25% vs. 13%) approaches.

More than 70% of financial advisors who are using smart beta are using more than one smart beta investment approach.

Among financial advisors who are currently using smart beta, just 28% are using a single smart beta investment approach. Half of smart beta users are using two or three different smart beta approaches, while 20% of users are using four or more.

 

The smart beta user profile has several notable characteristics.

Compared to non-users of smart beta, the profile of a financial advisor currently using one or more smart beta products has several evident characteristics.

Advisors who use smart beta are more likely to be younger, to have higher shares of AUM in ETFs and alternative investments and to have practices that extend beyond the core activities of investment selection, asset allocation and financial planning. As discussed earlier, smart beta users are more likely to

view smart beta as active management and they are more receptive to the newer smart beta approaches tested. Younger advisors are more likely to be using smart beta and are also more likely to have unaided familiarity with the term “smart beta.”

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