Smart beta has been a hot topic for investors this year as they seek to maximise returns in a low-yield world, but despite its growing popularity some investors remain unconvinced smart beta products can outperform the traditional market-cap weighted approach.
TrackInsight has compared the performance of two types of smart beta strategies tracking the MSCI Europe and S&P 500 indices – low volatility factor and a minimum variance strategy – to a corresponding market-cap weighted ETF over one and three years to prove that this is the case.
Low volatility and minimum variance (or minimum volatility) are two distinct approaches – the former consists of picking individual stocks or bonds with the lowest volatility in a given universe, while the latter is based around weighting stocks in a portfolio in such a way that the overall volatility of the portfolio remains low.
The research shows that both these smart beta approaches have outperformed their market-cap counterparts over one and three years, but also generally display good comparative tracking difference.
For example, the Amundi ETF MSCI Europe Minimum Volatility and iShares MSCI Europe Minimum Volatility products both significantly outperform Amundi’s MSCI Europe ETF, the market-cap version tracking this index with the best one-year tracking difference.
Yet despite the better cumulative performance, their tracking difference (TD) is not necessarily worse in comparison – Amundi’s minimum volatility product has a TD of just 0.04% over the year, compared to 0.14% for the market-cap ETF (though iShares has a TD of -0.40% for the year, dropping to -0.13% for three years versus a 0.13% TD for the market-cap ETF over the same period).
A similar picture can be seen among ETFs tracking the S&P 500 index – the PowerShares S&P 500 High Dividend Low Volatility, SPDR S&P 500 Low Volatility and iShares S&P 500 Minimum Volatility ETFs all outperform the BNP Paribas Easy S&P 500 ETF over one year.
All of them also have a better tracking difference over that period than the market-cap version – 0.42%, -0.11% and 0.21%, respectively, versus 0.59% for BNP Paribas’ ETF.
The data points to the fact these products can be a more efficient way to invest in well-established equity markets. But what do investors think?
In actual fact, flows so far this year to the end of July suggest investors are also favouring these strategies, as they seem to wake up to the smart beta revolution.
The assets in Amundi’s MSCI Europe Minimum Volatility product have increased seven-fold in the seven months, from €50m to €358.7m, while the iShares MSCI Europe Minimum Volatility fund has nearly doubled in size from €601.9m to €1.1bn. In comparison, the market-cap Amundi ETF MSCI Europe has lost some 40% of assets, dropping from €603m to €331.6m.
Similarly, the iShares S&P 500 Minimum Volatility ETF more than doubled in size from €623.5m to €2.1bn, and the PowerShares low volatility ETF has grown from a small size of just €5.8m in January to €248.6m in July. The BNP Paribas market-cap ETF, on the other hand, only gathered €10m over the period, growing to €175.8m.
The flows suggest the smart beta revolution is well underway, especially as markets are rocked by volatility resulting from Brexit and the US Presidential election campaign, among other concerns.
But it remains crucial to closely examine the data to pick the best products in the market and it pays to look under the bonnet of smart beta ETFs to understand exactly how their strategies work.
