“If minimising the cost of buying and selling is important – and intra day trading is important – ETFs might be a more attractive option.”
The rise of smart beta
There is, however, another variable to throw in the mix – and it is known as smart beta.
A smart beta ETF uses alternative index construction rules instead of the typical cap-weighted index strategy, taking into account factors such as size, value and volatility, making it also known as factor investing.
Smart beta strategies attempt to deliver a better risk and return trade-off than conventional market cap weighted indices.
Research by Invesco's ETF arm PowerShares shows most investors are using ETFs to access smart beta (see graph below).
Global assets in smart beta equity ETFs and other exchange traded products reached a new record high at the end of November 2016 of US$497bn, according to ETFGI, the independent research and consultancy firm.
Year to date to the end of November 2016, smart beta equity ETF/ETP assets increased by 18.1 per cent.
ETFGI reports assets invested in Smart Beta equity ETFs/ETPs listed globally reached a new record high of 497 billion US dollars at the end of November 2016
Market cap/Beta vs other forms of ETFs
Factor focused smart beta strategies allow investors to tilt their portfolios towards equity factors or styles for which they believe they will be rewarded over the long term, posing competition to active managers.
“The rise of so called ‘smart beta’ strategies has shone further light on the recent poor performance of stock picking managers in some markets,” James McManus, investment manager at robo-advice firm Nutmeg, says.
“By aiming to provide investors with systematic access to equity factors, smart beta strategies take away the ‘free lunch’ for active managers, and potentially help investors expose which of those have true stock picking skill, and which have just been harvesting a risk premia or a style factor for returns.”
However some are more sceptical of the rise of smart beta.
“I'm afraid personally I feel quite negative about the whole fad, given the confusion “smart beta” ETFs have generated amongst the retail customers that “should have” embraced them,” Luis Rivera, CEO and co-founder of robo-adviser ETFmatic.
“There is a lot of evidence that smart beta ETFs have outperformed traditional ETFs. But these studies are influenced by a short time horizon or back testing given the limited data available so far, and some are biased by chosen market sector or don't account for the additional costs.”
“The entire point of ETFs was to offer an antidote to the active fund manager trying to outperform the market without clear rules ex-ante. I’ve seen many models and black boxes that looked great in backtesting. We prefer simplicity and transparency.”
