Smart beta holds its own despite popularity of thematic ETFs

Thematic strategies have become darlings of the ETF industry, with managers pumping out products that seek to combine outperforming stocks and a story that investors can easily understand.

Their buzz was once the purview of smart beta, which emphasises investment factors that have been shown to deliver outperformance such as momentum, growth or value, but those products have faded in prominence among many managers’ line-ups.

However, smart beta and thematic ETFs need not be at odds for attention among ETF shops and investors, executives said. Though the two product categories may go after the same portfolio goal, they do so in very different ways — and shops can use both to their advantage.

“Conceptually, themes and sectors and factors are all the same — they’re building blocks,” said Denise Chisholm, director of quantitative market strategy at Fidelity.

This article was previously published by Ignites, a title owned by the FT Group.

Both smart beta, sometimes known as strategic beta, and thematic strategies group stocks that share similar characteristics. But the quantitative screens used to identify stocks that match a theme often result in portfolios that have a mix of sectors or factor tilts that can change as the theme plays out, Chisholm noted.

That makes thematic strategies, which have a long investment horizon, a “natural pairing” with specific factor and sector strategies whose attributes tend to be more discrete and easily analysed on their own, she added.

The rise of largely tech-oriented megatrend ETFs has accelerated since the start of the pandemic. Last quarter, 26 thematic ETFs launched in the US — bringing the total number of such strategies to 198, according to Global X. Assets in US thematic ETFs were up 128 per cent year on year, to $133.7bn at the end of September, the New York-based ETF shop’s data shows.

Last week, Fidelity and Invesco added to the thematic pile. Fidelity debuted four ETFs that cover themes including clean energy, cloud computing, digital health and electric vehicles. Invesco, meanwhile, partnered with Galaxy Digital to launch two ETFs targeting cryptocurrency and blockchain.

Both companies have also been big in the smart beta space. Fidelity had 13 strategic beta ETFs with a combined $4bn in assets as of September 30, according to Morningstar Direct, and Invesco had 119 with a total of $109bn in assets as of the same date.

Other factor-focused ETF players, including WisdomTree, First Trust and BlackRock, have also bet big on themes in recent years. Smart-beta launches, meanwhile, have slowed.

As of last week, 13 ETFs tagged by Morningstar as strategic beta had launched in the US this year. That compares with 21 for all of 2020 and 65 in 2017.

“People have moved on to get more granular, more active exposure through thematics,”  said Rolf Agather, head of research and product at Morningstar Indexes.

Themes also can be more straightforward for advisers to understand than factors, said Marc Zeitoun, head of strategic beta at Columbia Threadneedle Investments.

But in reality, managers can use a similar approach to explain factors. “There are two types of [investment] solutions: ones that provide access and ones that provide performance,” he said.

The fate of smart beta versus thematics also has a lot to do with the stocks that have been in favour, said Jeremy Schwartz, global head of research at WisdomTree, pointing out that for the past 10 years that popularity contest had been dominated by large US tech growth stocks such as Facebook and Netflix.

Meanwhile, smart beta strategies had been affected by the underperformance of low-volatility indices, noted Matthew Bartolini, head of SPDR Americas research at State Street. “Low volatility hasn’t been able to get out of its own way,” he noted. Such products have recorded 20 consecutive months of outflows, dragging down overall smart-beta sales, he said.

But even with those woes, and smart beta’s similarly heavy bent on value and quality factors that have not excelled since before the pandemic, sales of such products are in line with the five-year average, Bartolini said. Smart-beta products attracted about $44bn in net flows during the first nine months of 2021, according to State Street.

Strategic beta has also picked up a bit of market share in the past year. Some 18.8 per cent of all US ETF assets were in such products as of September 30, compared with 18.5 per cent a year earlier, according to Morningstar Direct.

“I don’t see thematic taking share away from smart beta,” Bartolini said.

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignites.com.

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