Across The Border

More Chinese investors expected to jump into ‘smart beta’ market

New asset class promises a better risk and return trade-off than conventional market-cap weighted indices: very appealing amid volatile markets

PUBLISHED : Tuesday, 30 August, 2016, 1:09pm
UPDATED : Tuesday, 30 August, 2016, 10:22pm

Despite capital inflow into “smart-beta” exchange traded funds (ETF) hitting a record high globally, takeup for the new breed of ETFs – which track every conceivable segment of the market – by Chinese investors remains cool.

The indifferent reaction so far is blamed on a lack of investment education and the country’s ongoing demand for higher yield. But analysts now believe the appeal of the new investment tool is spreading in the mainland.

Smart beta, also referred as strategic beta, represents a new middle ground for the active-to-passive investment spectrum.

They do not just passively track traditional market-capitalisation-weighted benchmarks, but tilt towards certain characteristics, called “factors”, such as dividend, growth or low volatility, when screening stocks in an index, according to definition given by Morningstar.

Experts say their increased popularity is linked to a desire for portfolio risk management and diversification as well as seeking to enhance risk-adjusted returns above cap-weighted indices.

At the end of June, total assets invested in globally-listed smart beta ETFs climbed to a record high US$429 billion, data from independent research firm ETFGI shows. Record levels of assets were seen in the United States, Canada, Europe and Japan.

Volatility-focused products gathered the largest net inflows, followed by those focused on dividend, amid the current risk-averse global sentiment.

However, in the mainland, the total assets under management (AUM) of smart betas shrank 56.1 per cent year on year to US$255.72 million by the end of June 30, with the number of products down from 14 to 13, according to Morningstar.

In Hong Kong, the asset values of smart beta funds inched up only 7.6 per cent to US$218.3 million, with product numbers rising from 12 to 15.

The return expectations of mainland retail investors is too high, and the return of smart beta ETFs cannot compete with some so-called ‘concept stocks’ within a short term
Yang Yu, co-CEO at Shenzhen-based iGoldenBeta Financial Technology

Yang Yu, co-CEO at Shenzhen-based iGoldenBeta Financial Technology, said that investor education remains the biggest problem.

“The return expectations of mainland retail investors is too high, and the return of smart beta ETFs cannot compete with some so-called ‘concept stocks’ within the short term,” Yang said, who’s also a former ETF manager.

The shrinking AUM was also the result of an overall lukewarm market sentiment, and mainland investors’ preference for short-term gain, he said.

After the A-share market crash in mid 2015 and the chaos triggered by the short-lived circuit breaker mechanism in January this year, the AUM of domestic mutual funds is still below last year’s level.

With mainland smart-beta ETFs buyers still demanding short-term investment, they simply withdrew their capital when market sentiment worsened, Yu said.

Jackie Choy, Morningstar’s Hong Kong-based director of ETF research for Asia, said smart beta products are more likely to outperform the market cycle, long term.

Patrick Kuhner, the client portfolio manager of Rosenberg Equities at AXA Investment Managers, said the different acceptance levels of smart beta between China and western markets is a clear reflection of the differences in market environments and client needs.

“Market volatility and drawdown has been a key concern of market investors in the US following the global financial crisis in 2008, so they have gravitated towards ‘lower volatility’ equity products,” Kuhner said.

As US institutions such as pension funds and insurance companies started doubting the effectiveness of active management, they headed towards smart beta ETFs.

However, mainland markets are still dominated by retail investors whose investment style and tools haven’t changed in two decades, Yang said.

“My expectation is that as Asia investors become more familiar with smart beta products and understand the role they can play in overall portfolio construction, we will see greater acceptance and an uptick in asset flows towards these various products,” Kuhner said.

In Hong Kong, the high-dividend factor was the biggest seller for its 15 smart beta ETFs now being offered.

BMO Asia High Dividend ETF, for example, doubled in size in a year to US$51.2 million, Moningstar’s data showed.

The only multi-factor product, the XIE Shares CLSA GARY ETF, launched this year also saw its AUM grow to US$12.6 million from zero.

Kuhner added smart betas’ appeal is they also offer access to global and regional equity markets with lower risk and lower drawdown profile, while still delivering market-like returns.

“This profile has become especially desirable in an equity market environment where increased volatility is likely to be with us for some time,” he said.

Hong Kong and mainland investors have also begun to expand their interest into blended smart beta products from simple single-factor products, Kuhner added.

The strategic beta ETFs in overseas markets – which have stronger efficiency – are mainly based on three single factors: dividend, growth and value.

For the mainland market, which is less informed and has weaker efficiency, more innovations in strategic betas can generate extra returns, iGoldenBeta’s Yang said.

Compared with active-managed funds, the fees for smart betas are also lower, Choy said.

“Strategic beta is a global trend and we expect to see more development in the Asia market,” he added.

“The overall market will grow.”