Strategic beta ETP market still expanding

Net new inflows globally amounted to US$87 billion - an organic growth rate of nearly 11%

Ben Johnson, CFA 14 March, 2019 | 2:00PM

Strategic or smart exchange traded products (ETPs) continued to expand in 2018, with net new inflows of US$87 billion, translating to an organic growth rate of nearly 11%. Over the past decade-plus, strategic-beta ETPs' market share has expanded considerably. Growth has been driven by new cash flows, new launches, and the entrance of new players—some of which are traditional active managers. However, more recently, the pace of these products' market share gains has decelerated as exchange-traded funds tracking more-traditional benchmarks have been garnering their fair share of net new flows.

At the end of December 2018, there were 1,493 strategic-beta ETPs, with collective assets under management of approximately US$797 billion worldwide.

Aside from slowing market share gains, this space is showing other signs that it is maturing, most notably a slowing pace of new product launches and increasing price competition. In 2018, the number of new product launches declined precipitously from the record level set in 2017. There were 132 new strategic-beta ETPs brought to market in 2018, down from 257 in 2017. The decline speaks to the fact that the menu has been saturated. This process of growth and maturation ultimately will lead to a culling of the herd, which has already begun in some countries, albeit to a limited extent.

An increasingly crowded and competitive landscape will also continue to put pressure on fees. We have already seen instances of aggressive fee reductions for strategic-beta ETPs. We anticipate that cost competition in this space will become more prominent in the coming years.

Dividend ETPs Prove Popular

ETPs belonging to Morningstar's dividend strategic-beta group continue to be among the most popular grouping of strategic-beta ETPs in most regions. This should come as little surprise when considered in the context of the prevailing interest-rate environment. Investors around the globe have piled into dividend-paying equities, shunning the low or negative real yields offered by issues from developed-markets sovereigns. Low-volatility ETPs gained market share in Canada, the United States, and Europe in 2018.

As for fees, strategic-beta ETPs tend to charge expense ratios that are more competitive than their comparable actively managed peers, though in some cases only marginally so. That said, in many cases they take a toll many multiples of that levied by their more ordinary passive peers. We expect that fees charged by strategic-beta ETPs will come under further pressure as providers seek to stand out in an increasingly crowded landscape where investors are having a difficult time differentiating between seemingly similar strategies.

Another commonality among the markets we examined is the increasing complexity of the benchmarks that are underlying new ETPs.

This is part of the natural evolution of the market and one that has already played out in the slicing and dicing of traditional market-capitalisation-weighted exposures along the lines of region, country, sector, subsector, and so on. As these strategies become increasingly nuanced, looking to infuse elements of an active manager's thinking into an index, investors' collective due-diligence burden will continue to increase commensurately. This has been further complicated by a growing number of instances of changes to the methodology of the indices underpinning these funds.

About Author

Ben Johnson, CFA

Ben Johnson, CFA  Ben Johnson, CFA, is director of global ETF research for Morningstar and editor of Morningstar ETFInvestor, a monthly newsletter.