How are Investors Positioned in Smart Beta?

In the U.S., a majority of Q1 ETF net flows were allocated to multi-factor and momentum, capturing 50% and 24% of Smart Beta ETF flows respectively. In contrast, Q4 2017 saw 31% of net flows go to Dividend, 22% to multi-factor, 18% to Value, and 11% to Momentum. Unlike last quarter, net flows were not positive across all factors. Low Volatility and Size experienced outflows, not surprising given the lackluster performance of both in recent history. However, the recent spike in volatility and resurgence of inflation concerns may reverse that trend.

In Europe, the narrative was noticeably different. In Q1 2018, Size and multi-factor captured the largest share of net flows, making up 86% and 20% of net flows respectively. Conversely Low Volatility (-21%), Dividend (-10%), and Quality (-10%) lost the most in the quarter. These trends were similar in Q4 2017.

Despite the differences in trends, the common theme that has risen to the surface is investor’s preference for a multi- factor approach when investing in Smart Beta.

Figure 1 Investors in U.S. and Europe are increasingly allocating to multi-factor ETFs.

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While diversification does not ensure a profit or guarantee against loss, investors in Smart Beta may diversify across a mix of factors to address cyclical changes in factor performance. However, factors may have high or increasing correlation to each other.

A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing.

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A “quality” style of investing emphasizes companies with high returns, stable earnings, and low financial leverage. This style of investing is subject to the risk that the past performance of these companies does not continue or that the returns on “quality” equity securities are less than returns on other styles of investing or the overall stock market.”

The stock/funds employs a momentum style of investing that emphasizes investing in securities that have had higher recent price performance compared to other securities, which is subject to the risk that these securities may be more volatile and can turn quickly and cause significant variation from other types of investments.

Low volatility stocks/funds can exhibit relative low volatility and excess returns compared to the Index over the long term; both portfolio investments and returns may differ from those of the Index. The fund may not experience lower volatility or provide returns in excess of the Index and may provide lower returns in periods of a rapidly rising market. Active stock selection may lead to added risk in exchange for the potential outperformance relative to the Index.

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