While some of the established managers are protected by unquestionable loyalty, a solid track record and established brands, smart beta disruption is challenging this by offering targeted exposure at a lower cost.
Globally, smart beta is the fastest growing segment of the investment management industry.
In Australia, approximately 10 per cent of exchange traded products (ETPs) are invested into smart beta
In the US, smart beta products capture nearly a quarter of the market.
Loyalties to active fund managers are being quickly eroded as investors smarten up to the reality of their underperformance.
Whether retail or institutional, investors are demanding greater transparency and performance from their investments.
So they are walking away from fund managers who are hugging their benchmarks but still charging high fees – and they are turning to smart beta.
In January 2016, the CFA Institute’s Financial Analysts Journal published an article by Ronald Kahn and Michael Lemmon titled The Asset Manager’s Dilemma: How Smart Beta is Disrupting the Investment Management Industry.
Mr Kahn and Mr Lemmon write that “the ultimate goal of disruptive innovation in investment management is to deliver superior investment outcomes and meet investors’ needs (as opposed to requests). In the case of smart beta, the investment outcome is higher returns and/or lower risk after fees and costs. The innovation is motivated by a vision of how clients ought to invest – even when they do not realise a change is needed". 
Explaining smart beta
Smart beta ETFs are at the forefront of smart beta investing. They combine aspects of active and passive management by tracking indices that deliver a targeted investment outcome.
Yet they retain the transparency, liquidity, ease of trading and rules-based approach of market-capitalisation based index ETFs.
Traditionally, most ETFs followed conventional market capitalisation weighted indices.
However, smart beta strategies enable investors to achieve targeted investment outcomes by tracking indices that actively identify a factor or investment approach they want in their portfolio.
Various approaches can then be used simply as building blocks to develop well-diversified strategic portfolios that aim to target improved portfolio outcomes.
These smart beta strategies generally come at a fraction of the cost of actively managed funds.
There are several different types of smart beta strategies, including:
Flows speak volumes
By carving out a significant component of active management and offering it based on a rules approach, offering greater transparency and more cost effectively, smart beta ETFs are quickly drawing investors’ attention.
As the popularity of smart beta grows, so too will flows into ETFs that adopt these targeted strategies.
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