SPONSORED FEATURE: Harnessing the rise of smart beta

There is no doubt that Smart Beta ETFs are gaining traction in Europe. In June 2016, they reached €19.7 billion in Assets under Management, up 31% versus the end of 20151. In this article we look at what is driving the rise, and how investors could capitalise on it.

The rise of Smart Beta ETFs can no longer be ignored. This year, they have attracted €6.1bn in net new assets (until July 30), far above that of 2015, where €4.1bn was collected across the entire year. This is even more remarkable when you consider that equity ETFs globally registered outflows over the same period of €1bn1.

Part of the reason is the more sophisticated and cost-conscious nature of investors today.  These strategies go beyond regular index-tracking funds where constituents are selected and weighted according to size, and use other risk or fundamental measures to determine the portfolio. The result is a much more strategic approach that echoes much of the principles used in the active fund world. However, by using a pre-determined set of rules to determine the strategy, rather than the discretion of a fund manager, Smart Beta can not only reduce costs, but also improve transparency.

What this means is more power to the investor. Your choice is no longer dictated by where you want to invest, or the size of company you are targeting. You can select a Smart Beta ETF according to what you want to achieve. This is particularly useful when trying to navigate the complex nature of financial markets.

TAMING INCREASINGLY UNCERTAIN MARKETS
We invest in unprecedented times. Monetary policies are increasingly diverse, growth prospects increasingly uncertain and political environments increasingly unstable. As illustrated in chart 2, which shows the historical volatility of the S&P 500 Index, volatility has been increasing in recent times. Although not exact, this measure can be taken as a good proxy for global equity volatility.

Against this backdrop, portfolio managers have sought new ways to hedge or control risk. Low volatility Smart Beta strategies such as Minimum Variance ETFs have proved a popular way to reduce risk. Year to date, minimum volatility ETFs have gathered around €4.4bn in new assets, €1.1bn of that in July alone2.

For our Minimum Variance ETFs, we selected the FTSE Minimum Variance index series, which aim to reduce the risk of investing in Europe, America, Emerging Markets or the global stock market. They do this by focusing their exposure around the less volatile, less correlated stocks from the original benchmark portfolio. In traditional Minimum Variance strategies, this can lead to quite restricted portfolios concentrated around a limited number of stocks. The FTSE approach is different. By applying a number of diversification targets, FTSE’s Minimum Variance indices typically maintain more than twice as many stocks in their portfolio, helping to spread risk. 

The more diversified nature of our Minimum Variance ETFs helps to create greater stability and maintain a more consistent source of outperformance. Over a one-year period, our Diversified Minimum Variance ETFs have outperformed their benchmark by between 3.2% and 9.7%. Over a five-year period, this extends to between 21% and 30.8%.

SOURCES OF GROWTH
Equity markets have become increasingly correlated as central banks have pumped liquidity into the system, leaving investors searching for new sources of diversification or performance. Risk Factor ETFs have been one of the great beneficiaries, collecting €1.5bn in new assets between January and the end of June 20161.

Why are Factors proving so popular? Performance. Factors provide a framework for allocation that goes way beyond geography or company size, allowing investors to target stocks that exhibit the same attributes or behaviours. Lyxor’s Factor framework focuses on five core factors which, together with the simple return of the market, explain over 90% of portfolio returns; Low Size, Value, Quality, Low Beta and Momentum. By isolating these from within an equity universe, investors can target additional performance or add diversification to a portfolio.

Investors can target each factor independently through single-factor ETFs, or a multi-factor ETF that covers all five. Multi-factor strategies gathered the bulk of inflows year to date at €873m1. But flows on Single factor strategies, especially quality, value and low beta, are gathering pace.

THE HUNT FOR YIELD
It is an oft-quoted fact that traditional sources of yield such as cash or government bonds are producing low or even negative yields. One big knock-on effect is that investors are being driven towards more risky alternatives to satisfy their need for income; opting for high yield bonds, or turning to the equity markets. 

Smart Beta can provide an answer to this dilemma too. In particular, the quality income indices created by Andrew Lapthorne, Global Quantitative Research Strategist at Societe Generale, provide an income strategy with a difference. These are designed to not only provide a high yield now, but one that can be sustained over different economic cycles. They do this by focusing on approximately 75 ‘High Quality’ companies, whose strength makes them more likely to sustain their dividend when markets fall, and grow it when they rise. These are some of the most stable in the world. For their shares to be selected, companies must have a robust business, have a strong balance sheet and provide a yield of more than 4%.

The philosophy of Quality Income indices follows three principles: Dividend Yield is the driver of equity returns, Quality stocks are less likely to cut dividends and high-quality stocks are some of the world’s most stable companies. How has the strategy held up? Over a one-year period, the SG Global Quality Income Index has outperformed the MSCI World Index by 4.6% with less volatility (15.92% vs 18.95%). This outperformance and lower volatility has equally been observed over a ten-year period3.

Lyxor’s SG Quality Income ETFs are available on a global or European basis, in various currencies and in capitalising or distributing share classes. The funds hold over $800m in assets as at August 20164.

CUSTOMER NEEDS
Lyxor’s approach to smart beta is research-driven. Our team of academics design custom-made proprietary index strategies, and work with carefully selected third-party index providers. We manage over $12.9bn in smart beta strategies across the ETF and Asset Management side (as of June 2016). What is common to all our Smart Beta strategies is that they are designed around specific investor objectives. That may be to control risk, enhance returns or generate income. Each strategy uses clear rules based on risk or fundamental criteria to select and weight stocks. You can find out more at www.lyxoretf.com

THIS COMMUNICATION IS FOR ELIGIBLE COUNTERPARTIES OR PROFESSIONAL CLIENTS ONLY
This document is for the exclusive use of investors acting on their own account and categorized either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2004/39/EC. These products comply with the UCITS Directive (2009/65/EC). Lyxor International Asset Management (LIAM) recommends that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to [email protected]. Lyxor International Asset Management (LIAM), société par actions simplifiée having its registered office at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorized and regulated by the Autorité des Marchés Financiers (AMF) under the UCITS Directive and the AIFM Directive (2011/31/EU). LIAM is represented in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658.

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