Investors deeply concerned by smart beta transparency

Nine out of 10 investors are harbouring major concerns over the lack of transparency in the smart beta ETF space, according to research by EDHEC-Risk Institute.

Investors deeply concerned by smart beta transparency

The report, which surveyed 222 professional investors across the UK and Europe and was published 23 June, showed that 88% of those questioned saw a lack of transparency around smart beta indices as a “major concern”.

Respondents highlighted methodology and risk analytics processes as the primary areas requiring increased clarity, with the vast majority of investors unsure as to how potential smart beta investments operate.

Furthermore, 82% of those questioned outlined capturing factor premia as their main priority when investing in smart beta ETFs, putting forward – in order of importance – ease of implementation, low turnover and transaction costs, a rational risk premium, and documentation of the factor premium in empirical literature as aspects they look for when considering products.

However, Peter Sleep, senior investment manager at Seven Investment Management, suggested that it is not a lack of transparency around the products themselves that is the issue, but rather the amount of time that investors are able to commit to examining the mechanics.

“I cannot see why people believe that there is a lack of transparency,” he said. “A market-cap index is very intuitive, whereas a smart beta strategy requires a bit more work – it could be a case of investors saying ‘it must be opaque’ rather than it actually being opaque.

“It may be a time issue. Investors do not have the time to spend on it, therefore they are not going to look at it, and that is what makes some the SNP and FTSE ETFs so popular.

“Smart beta ETFs use risk analytics features to reduce tracking error, while also trying to maintain the minimum variance of whatever the smart beta is. You do need to spend time looking at the risk analytics, but they are all there and available to be read about and discussed.”

Despite the apparent reticence over smart beta ETFs, almost three-quarters of those that have invested in the space expressed satisfaction, with 74% saying that they are pleased with the products they are using.

This translated into investor desire for more smart beta products with the ETF space, with smart beta equity (37%), equity factor (31%), equity style (29%), and smart beta bond (25%) occupying four of the top six priorities.

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