Strategic Beta: Expect Lower Fees and a Better Fund Range

LOW COST FUNDS: The introduction of new Strategic Beta strategies continues to increase options available to investors looking for active fund returns for passive prices

Emma Wall 1 October, 2015 | 12:06AM
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Emma Wall: Hello and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Kenneth Lamont, Passive Fund Analyst with Morningstar.

Hi, Kenneth.

Kenneth Lamont: Hello, Emma.

Wall: So, we're here today to talk about the latest strategic beta report from the passive fund analyst team. What are the biggest findings this year?

Lamont: Well, the biggest findings, we're sort of building on the research last year and we found sort of more of the same. We found the European strategic beta ETP market has been growing, continued to grow aggressively throughout the year. We've seen the number of funds expand by a third since last year and sort of the AUM growth over the last five years has now reached sort of four times. There has been a four-fold increase.

Wall: And the U.S. still have majority of this market which is unsurprising because the U.S. is the most mature passive fund market. But the European strategic beta sector is growing, isn't it?

Lamont: Certainly, yes. It's growing faster than the wider ETP market and every year we're seeing it take more and more market share. Yeah, it's just a very – it's one of the fastest growing sort of new products on the market, if you like.

Wall: And within that obviously it's a sort of one-way trajectory. People are becoming much more interested in these products. What is the appeal? Why are people becoming interested in these products?

Lamont: Well, it's very, very simple. These products offer traditionally active strategies for a significantly lower fee than active managers. And just to explain, these products track – systematically track an index, but the index is generally not cap-weighted. So, you're making an active bet against the market, but you're doing so in a rules-based manner.

Wall: And what are the most popular of these strategies?

Lamont: By far at the moment in Europe and actually globally dividend ETFs or ETPs are strategic, so these funds are weighted or selected on their ability to produce dividends, strong dividends through time.

Wall: And no surprise there, because interest rates across the developed world have been so low for so long. What about new entrants to the market?

Lamont: Well, as we see the main core exposures in the market, more and more providers enter the market. We're seeing a sort of crowding out effect. We're seeing the fees for these products, as you might expect, creep lower and lower which is great for the consumer.

Wall: And they are already at low starting point, so even cheaper active like strategies is fantastic?

Lamont: It's great for the consumer. And in response, we've seen providers branch, sort of expand the breadth of products on offer. So, currently, this year we saw the first buyback strategies and the first low beta strategies enter the European market. So, this is broadening the opportunity set for investors.

Wall: And predominantly they are equity strategic beta ETFs, ETPs, aren't they? What do you expect to see in the future? Will there be sort of greater diversity of asset classes?

Lamont: Well, we expect to see all of these trends continue. If you look at the U.S., we can see that – which is a sort of more mature market, it has a far larger market share. So, if we use that as a barometer, we can see a real – there is a huge amount of scope for growth in Europe. They are increasingly sort of popular.

But in terms of the trends, we expect them all to continue. So, we expect the prices of the core offerings to continue to fall in the medium term and in response to this we expect the breadth of offerings to increase and the complexity of offerings.

And as you said, the sort of final point is that up until now or this point most of the developments have been focused on the equity markets and I think looking forward, we can really expect more specifically in the fixed income markets we can expect a lot of movement there over the next couple of years.

Wall: Fantastic news for the consumer?

Lamont: Absolutely.

Wall: Kenneth, thank you very much.

Lamont: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar