What is beyond Advanced Beta?

Advanced beta, smart beta, alternative beta – whatever you want to call the indexing strategy that steps away from traditional market cap-weighted – is here to stay. These strategies have successfully carved out a significant share of the ETF market, and their rise to prominence is further increasing with the emergence of “multi-factor” advanced beta strategies that are quickly picking up steam.

Recently, it was widely reported that investors hungry for an alternative solution to market cap-weighted funds have invested over $500 billion into advanced beta ETFs. This is a significant milestone that signals some trends about the future growth of the ETF industry.

Advanced beta strategies differ from traditional index products in that they weight their portfolio holdings not on a company’s market capitalization, but rather on one of five “post modern portfolio theory” factors – low beta, momentum, quality, size and value – in an attempt to capture market returns while managing risk.

Investors, particularly financial advisors, are looking for more refined ways to build portfolios beyond the traditional cap-weighted funds that defined the ETF industry in its early days.

Let’s first take a look at advance beta’s rise to cross the $500 billion threshold.

As ETFs become advisors’ and investors’ tool of choice to gain market exposure, the ability to gain “active share” through the use of advanced beta and other strategies has driven use amongst advisors. These strategies allow advisors to express more customized investment experiences for their clients and can be a differentiator in performance and risk management.

Because advisors are increasing their usage of advanced beta ETFs, many traditional mutual fund companies see these products as a natural extension of their existing business model. To cater to these advisors who have adopted advanced beta ETFs, many mutual fund companies have entered the ETF space and are providing advanced beta solutions.

So why have advisors pivoted away from cap-weighted portfolios?

Feeling the pressure from the highly competitive nature of their industry, advisors want to differentiate themselves. One way to do this is through portfolio strategies that embrace new ways of viewing the markets, the key feature of advanced beta ETFs.

Think of it this way: If every advisor – and therefore every investor who hires an advisor – is using S&P 500 or Russell 1000 products, everyone’s performance will be similar depending on their asset allocation but will also be largely dependent on the broader market. In an effort to stand out, advisors, acting on behalf of retail investors, have begun utilizing advanced beta strategies to express a more specific view on the market and are fettering out opportunities for one of the advanced beta factors to outperform or provide better risk management.

As the different types of market exposures and investment factors continue to evolve, advisors and investors will need to keep their eyes on the next iteration of ETFs. Technology has allowed the discussion around security performance to move beyond advanced beta into new areas of security

analysis. These strategies are increasingly becoming available in ETFs and allow advisors and investors even more portfolio tools.

ETFs are now utilizing proprietary factors and strategies to take the final step toward introducing truly active thought into ETF portfolios. Ultimately if an advisor wants to differentiate their business and deliver attractive returns, one needs to invest in a strategy that will be able to provide value over the long term.

The growth of advanced beta and other next generation solutions for advisors seems to be a promising sign that the ETF industry is ready to assume a larger part of the wealth management marketplace of the future.