Jumping on the smart beta bandwagon

Asia has been slow to embrace smart beta investment strategies, but this is beginning to change with an increase in sustainable investing and institutional investors in the region – such as insurers and pensions managers – looking to protect portfolios amid a strong run in equity markets.

The adoption of smart beta in Asia had lagged because of limited investment in building smart beta exchange-traded products, misaligned incentives or higher remuneration for brokers to promote other products and, until recently, a lack of investor knowledge. Most of these issues have now been addressed.

So far, the majority of smart beta exchange-traded fund (ETF) investors in Asia have been Japan- or Australia-based. Japan accounted for the largest share of assets under management (AUM) in smart beta ETFs, with $7.3 billion invested. Initiatives from Japan’s Government Pension Investment Fund (GPIF) and the Bank of Japan to encourage investors to increase their exposure to ETFs have contributed to these inflows. While smart beta ETF assets in Asia-Pacific including Japan grew by 57% in the year to June 2017, the asset class in the region represents only 4.3% of total ETF assets, which now stand at $390 billion, according to Morningstar. 

The first smart beta index in China – the China Securities Index Company’s Research Affiliates Fundamental Index – was only launched in 2009. The first ETF based on it was released a year later – almost seven years after the first smart beta fund was launched in the US.

Interest is picking up, however – especially in China, where insurers are keen to jump on the bandwagon. This increasing interest in smart beta in Asia coincides with intensified demand for sustainable investing.

China is currently responsible for 30% of total global investment in renewable energy and 27% of investment in energy efficiency, according to the International Energy Agency. Furthermore, the GPIF is promoting engagement strategies to encourage shareholders to push companies towards more sustainable practices. 

Investors are looking for index products with green exposures and ways to incorporate sustainability metrics alongside traditional financial ones. 

One way smart beta has been used to incorporate environmental, social and governance (ESG) investing is through an ESG filter, overlaid onto a fund that assesses a number of factors. Although this reduces the investment universe, risk-monitoring tools can be used to ensure the performance of the fund. 

However, those looking into smart beta and ESG in Asia must be conscious of not trying to replicate successful strategies elsewhere without accounting for regional differences. For example, ESG issues such as air pollution may be a more important consideration in Asia than in other regions.

Equally, features of less-developed markets – such as the large number of state‑owned enterprises in China – must be considered when putting together an effective smart beta strategy there.

Another factor generating demand is that smart beta decisions are essentially driven by data and enhanced with technology. As the two enablers advance, the execution of smart beta strategies becomes increasingly consistent and inexpensive from a fund management perspective. For fee-conscious Asian investors struggling with global falling returns, this provides an opportunity – rising interest in Asia coincides with a global surge. Smart beta ETFs accounted for about $430 billion, with new inflows of more than $45 billion recorded in 2016, according to Morningstar. Fund manager BlackRock predicts that total AUM in smart beta ETFs will grow to $1 trillion by 2020, and to $2.4 trillion by 2025.

Read more articles from the Smart Beta and Factor Investing Special Report