Smart Beta: All you need to know about the ETF strategy that’s returning up to 31pc annually
While some of the most prominent ASX ETFs are sector focused, others that use so-called “smart beta” strategies have been growing in popularity.
Van Eck‘s annual Australian Smart Beta survey, which questioned 547 financial advisors, found 91% of advisers use ETFs in client portfolios and 56% use smart beta ETFs.
The survey did find that 9% of respondents did not use smart beta ETFs with the biggest reason being they did not know enough about them.
But 75% of survey respondents believe smart beta strategies will become more prevalent going forward.
So, just what do smart beta strategies involve?
Van Eck says in the context of ETFs, it’s about tracking an index but considering more than just market capitalisation.
“The way you’d define smart beta is the intersection between active management and what I call pure market cap,” Arian Neiron, Van Eck’s Asia Pacific CEO and managing director told Stockhead.
“The ASX 200 takes the top 200 stocks, takes what their free floats available, what their value is and weights them based on that; it doesn’t take into consideration anything in terms of fundamentals of the company.”
But smart beta strategies involve looking at long term identifiable drivers of return, such as return on equity, financial leverage and earnings and taking them into consideration as well.
“Some styles are value or quality – and by way of example, quality targets companies with high return on equity, low financial leverage and style earnings. The thing with smart beta is, these are long term identifiable drivers of return,” Neiron said.
“Fund managers think they have an investing edge, the reality is they don’t.
“For the most part, the average active manager doesn’t outperform the index and where smart beta comes into play, full transparency, it’s rule-based, target an outcome.
“You can design a portfolio where [for example] you can buy ASX 200 but want to downweigh the banks, so you take equal weighting and that gives you a greater distribution of your portfolio to the midcaps,
“Investors – it doesn’t matter how big or small they are – are using smart beta to lower costs, they’re increasing their transparency and targeting outcomes. And I think that’s a key for portfolio construction – you want to target an outcome.”
Two such example of ASX ETFs with active beta strategies is Van Eck’s International Quality ETF (ASX:QUAL) and VanEck Morningstar Australian Moat Income ETF (ASX:DVDY).
The first of these tracks the MSCI World Quality Index – excluding Australia – which has 300 companies with high return on equity, low financial leverage and stable earnings.
“Why is quality important? When systemic issues in markets and heightened volatility (appear), investors fly to quality and so quality stocks in a down market outperform, and rate of recovery is faster than what you compare it to the market cap,” Neiron said.
“When you have low growth, low inflation environment quality stocks do better.
“They don’t do well when interest rates go up, high inflation, high growth rate – what happens then is cyclical stocks, stock where their earnings are more correlated to earnings cycle, when you put more debt on then quality stocks underperform.”
Neiron also explained the DVDY ETF, noting despite the ASX code it was more than just the big dividend payers.
“That’s targeting the wide moats – a strong comparable advantage over the long term but those companies that have free cash flow to overcome downturns to pay dividends even when there are downturns,” he said.
QUAL has returned 31% while DVDY has returned 24% in the last 12 months.
Van Eck’s survey also found ETFs have grown in popularity.
In the 12 months to 31 August, 2021, the ETF market capitalisation reached $122.78 billion, growing by 74% during those 12 months.
The same percentage of respondents to Van Eck’s survey have indicated they will hike their exposure to ETFs in the next 12 months.
Neiron said it was because ETFs allowed investors to get similar expertise to that offered by professional fund managers but with far greater ease.
“The reality is, whether an ETF is smart beta, active or ASX 200 – it is democratising the investment opportunity,” he said.
“People want to go on the ASX throughout the trading day, they don’t want to send an application form to a fund manager and wait 5-7 days before they get a confirmation statement.
“The reality is last year with COVID we had an acceleration of digitisation. People were obviously homebound, looking at portfolios and ETFs as well.
“I think there’s incumbency in Australia with active managers and the COVID market meltdown was really an inflection point for people to take losses or gains off the table and then start to allocate to ETFs and they’re growing year on year.
“Our strategies have been why investors have been allocating.”