Asia investors turn to smart-beta ETFs as active managers' results disappoint

Investors in Asia are embracing smart-beta exchange-traded funds that can boost profits and cut costs in the current climate of low investment returns and even lower interest rates. Traditional beta measures the volatility of a security in relation to the market. Smart-beta products are index funds that include more factors in investment decisions than pure passive strategies do, taking into account volatility and market inefficiencies to generate higher returns.
This strategy makes smart-beta investment a little more expensive to manage than traditional index funds, which simply mimic the composition of a benchmark, but cheaper than actively managed products. Assets under management in smart-beta ETFs grew 47.5 percent to $10.5 billion in the 12 months through June in the Asia-Pacific, according to Morningstar data. The number of smart-beta ETFs rose to 130 across the region from 97 a year earlier, the figures showed.
"Investors have realized that US interest rates will not rise fast, and they still need a steady income stream," said David Quah, product specialist at Mirae Asset Global Investments in Hong Kong. "And this year, in view of the easing in Europe and Japan, it's difficult to get income stream from bonds. So investors are turning to high-dividend stocks."
Mirae has seen rising flows into its low-volatility, high-dividend ETF that tracks the Hang Seng High Dividend Yield index, he said. The firm also has nine smart-beta ETFs listed in South Korea employing a number of smart-beta strategies. In a low interest rate environment, actively managed funds become costly for investors, particularly when they do not outperform passive strategies.
For instance, the average expense ratio for smart-beta ETFs investing in Hong Kong equities is 0.67 percent, versus 1.77 percent for actively managed funds, according to Morningstar. Yet, passive strategies have, on average, outperformed active management in seven out of 11 markets in Asia, including Hong Kong, over the past three years, Morningstar data shows.
"When the return is 12 percent, paying 1 percent is okay," said Jason Hsu, chief executive officer of Rayliant Global Advisors in Hong Kong, which plans to offer smart-beta ETFs focused on Chinese equities next year. "If the expected return is 6 percent, paying 1 percent in active fees might feel like too substantial a cost." Australian pension fund CBUS Super began investing in smart-beta strategies in 2011 for global equities, starting at 5 percent of its world stocks portfolio.
That share, employing value and low-volatility strategies, has now risen to 20 percent, and CBUS may expand smart-beta to domestic small-cap stocks and emerging markets too, said Brett Chatfield, general manager for public markets at CBUS. Smart-beta products have proven especially popular in Japan, where negative interest rates and a strong yen have weighed on company performance. Blackrock's iShares unit listed two smart-beta products in Japan late last year, one focused on minimum volatility and the other on high dividends.
Nikko Asset Management listed one high-dividend, low-volatility smart-beta ETF on the Tokyo Stock Exchange in December. "In Japan's low-interest environment, there is strong demand from clients for high dividends," said Koei Imai, head of Nikko's ETF Centre. Japan accounted for the biggest slice of assets under management in smart-beta ETFs, with $7.3 billion invested. Initiatives from the Government Pension Investment Fund and the Bank of Japan to get investors to increase their exposure to ETFs have driven some of these inflows.
Despite the growth, the Asia-Pacific region accounts for just 2 percent of smart beta assets under management and 12 percent of the number of smart-beta ETFs, according to Morningstar. The US accounted for 89 percent of the assets and 54 percent of the total number of products.
"We will see a greater number of smart-beta ETFs list in the Asia Pacific, and those funds, and those that exist already, attract inflows," said Susan Chan, head of iShares Asia Pacific. "That will be driven by increased knowledge of how to use smart-beta ETFs, lower returns across asset classes globally, and a greater focus on investment cost regionally, as has happened elsewhere in the world."