Snapshot: THE STATE OF Advanced Beta IN EUROPE Beyond Active and Passive A research report sponsored by State Street Global Advisors.
Advanced Beta is the Latest Stage in the Evolution of Indexing As the distinction between active and passive investing begins to merge, Advanced Beta strategies are experiencing unprecedented growth. Morningstar Investment Consulting France analyses the current fund landscape in Europe. Advanced Beta, sometimes also referred to as smart beta, has quickly established itself in today s investment universe and these innovative approaches have proliferated in recent years. Generically, these are rules-based, transparent investment processes that look to isolate factors that have been shown to outperform market-cap-weighted indexes over time. The majority of these indexes seek to enhance returns or minimize risk relative to a traditional market-cap-weighted benchmark. Others seek to address certain oft-cited drawbacks of standard benchmarks such as concentration in equity cap-weighted indexes or the overweighting of the most indebted issuers that is prevalent in market-cap-weighted fixed income benchmarks. These strategies can exploit many of the same sources of return (e.g. size, value, quality, momentum) that active managers target or seek to mitigate risk in a similar manner.
Advanced Beta Funds are Gaining Popularity in the Market In early 2015 Morningstar conducted an in-depth analysis of the European Advanced Beta listed fund universe on behalf of State Street Global Advisors. This analysis uses the Morningstar taxonomy for grouping open-ended funds into Advanced Beta categories to give a unique look into the current European landscape for these funds. Initially developed for institutional needs and available under mandate or dedicated funds formats, the industry has moved to the next stage with Advanced Beta offering increasing numbers of open-ended funds. Advanced Beta funds in Europe have grown both in absolute numbers and by assets gathered. Sophisticated investors have been using Advanced Beta for quite some time but the range of accessible Advanced Beta funds in Europe has seen incredible growth in recent years. The number of Advanced Beta funds is growing almost as quickly as research firms can come up with new strategies and new indexes to track. At least some of their growth can be attributed to rising doubts about the effectiveness of active management and awareness around some of the weaknesses of market cap-weighting. But Advanced Beta indexes are not designed to replace traditional marketcapitalization-based indexes. Rather, they are a complement to the existing indexes and active strategies available to investors, allowing for finer cuts on market exposure, factor exposure and portfolio-weighting approaches. They re a new key on the piano for investors. In the following pages we demonstrate just how extensively this area has grown, where the current focus is and give insight into where it is likely to be in the near future. State Street Global Advisors 3
Snapshot: The State of Advanced Beta in Europe The Most Popular Asset Classes Advanced Beta is a market clearly driven by equity: with almost 62 billion in equity via 246 funds, the size of the entire category the year before. Over 85% of total assets are invested in these products. AUM in this category grew 39% versus 2013 year-end levels, after equally impressive growth in previous years. Number of funds Assets in bn Market share (%) Global Broad Category 2013 2014 2013 2014 2013 2014 Equity 233 246 42.74 61.83 81.70 85.01 Commodities 35 35 2.05 1.58 3.90 2.17 Fixed Income 27 27 5.39 7.22 10.30 9.93 Alternative 20 20 0.77 0.49 1.50 0.67 Allocation 14 14 1.26 1.52 2.40 2.10 Miscellaneous 3 3 0.09 0.09 0.20 0.12 Total 332 345 52.29 72.73 246 35 Equity Funds Commodities Fixed 27 20 14 Income Alternative Allocation 3 Miscellaneous Advanced Beta Fund Numbers by Asset Class 2014
Recent Years Have Seen Tremendous Asset Growth Within European Funds From around 2004, with the development of fundamental index strategies, Advanced Beta truly began to grow aggressively. Before this period, some High Dividend strategies were available but the terms Smart or Advanced Beta were not then in widespread usage. The actual number of funds has almost tripled in 5 years: from 123 funds to 345 funds. Advanced Beta Growth by Asset Class 2000 2014 bn No. of Funds 80 400 60 300 40 200 20 100 0 2000 2002 2004 2006 2008 2010 2012 2014 0 Equity Commodities Fixed Income Alternative Allocation Miscellaneous Advanced Beta Growth by Asset Class 2000 2014 Assets in bn 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Equity 1.06 0.98 0.64 0.60 1.31 8.46 13.38 15.35 9.15 13.36 17.34 20.19 29.48 42.74 61.83 Commodities 0.03 0.07 0.09 0.22 0.26 1.22 1.80 1.48 2.19 2.05 1.58 Fixed Income 0.31 0.36 0.28 0.25 0.08 0.20 0.80 1.49 1.55 3.19 5.39 7.22 Alternative 0.01 0.04 0.16 0.56 0.61 0.90 0.77 0.49 Allocation 0.08 0.12 0.12 0.15 0.14 0.16 0.14 0.41 1.00 1.40 1.93 1.26 1.52 Miscellaneous 0.02 0.03 0.07 0.08 0.08 0.09 0.09 Total 1.06 0.98 0.72 1.03 1.82 8.96 13.85 15.82 9.80 15.98 22.26 25.31 37.77 52.29 72.73 Number of funds 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Equity 2 3 5 5 11 33 45 77 92 106 122 154 191 233 246 Commodities 0 0 0 0 1 1 1 2 2 6 18 31 32 35 35 Fixed Income 0 0 0 1 1 1 1 2 2 5 7 15 21 27 27 Alternative 0 0 0 0 0 0 0 1 2 2 4 8 14 20 20 Allocation 0 0 1 1 1 1 1 1 3 3 4 6 9 14 14 Miscellaneous 0 0 0 0 0 0 0 0 2 1 3 3 3 3 3 Total 2 3 6 7 14 36 48 83 103 123 158 217 270 332 345 State Street Global Advisors 5
Snapshot: The State of Advanced Beta in Europe Growth Galvanised After the Global Financial Crisis Interest in Advanced Beta was further fuelled by the 2007 08 Global Financial Crisis. The Crisis prompted many investors to become more focused on controlling risks rather than simply maximising their returns. While there is no one, single reason that explains the recent rise of these strategies, their growth is often attributed to rising doubts about the effectiveness of active management, the ever-increasing desire to keep a lid on investment management fees, and investors growing awareness of the weaknesses of market-cap weighting. Advanced Beta Asset Class Growth By Euro Post-GFC bn 80 60 40 20 0 16bn 22bn 25bn 38bn 52bn 73bn 2009 2010 2011 2012 2013 2014 By Fund Numbers Post-GFC Number of Funds 400 332 345 300 217 270 200 100 123 158 0 2009 2010 2011 2012 2013 2014 Equity Commodities Fixed Income Alternative Allocation Miscellaneous Source: Morningstar, as of 31/12/14
Europe leads the way on Advanced Beta. Advanced Beta in Europe has seen explosive growth in recent years, from less than 2 billion in 2004 to nearly 73 billion at end December 2014. An increase of 3550 % in a decade. As at end December 2014 73 BILLION is invested in 345 FUNDS from 2009 to 2014 356 % 181 up up value of assets % number of funds State Street Global Advisors 7
Snapshot: The State of Advanced Beta in Europe Which Strategies are the Most Popular? Under Morningstar classification the most popular strategies in Europe are Low Volatility/Equal Weight. There was more than 26 billion invested in 106 funds, as at the end of 2014. Next come Dividend and Fundamental Weight strategies, with over 22 billion and 18 billion, respectively. In terms of number of funds, however, the Fundamental Weight strategies had nearly 1.5 times more funds than dividend strategies (97 vs 68). Despite a relatively significant number of funds (43) the enhanced futures strategy collected only 1.83 billion in assets less than the maximum diversification strategy, with a mere 13 funds available for sale. Assets by Advanced Beta Strategy 2013 vs 2014 Number of funds Assets in bn Market share (%) Advanced Beta Strategy 2013 2014 2013 2014 2013 2014 Low Volatility / Equal Weight 101 106 17.44 26.16 33.3 36.0 Dividend 64 68 15.84 22.69 30.3 31.2 Fundamental Weight 95 97 13.54 18.13 25.9 24.9 Enhanced Futures Strategy 43 43 2.35 1.83 4.5 2.5 Maximum Diversification 13 13 2.16 2.60 4.1 3.6 Value 9 10 0.72 1.17 1.4 1.6 Growth 7 8 0.25 0.14 0.5 0.2 Total 332 345 52.29 72.73 Market Share by Advanced Beta Strategies Advanced Beta Market Share 2014 by Assets Low Volatility/ Equal Weight Dividend Fundamental Weight Maximum Diversification Enhanced Futures Strategy Value Growth 26.2 bn 22.7 bn 18.1 bn 2.6 bn 1.8 bn 1.2 bn 0.1 bn 106 68 97 13 43 10 8 by Fund NUMBER Source: Morningstar, as of 31/12/14
Advanced Beta Fund Asset Growth 2004 2014 bn 80 60 No. of Funds 400 300 Growth in AUM AUM growth in these strategies shows a strong upward trend suggesting that far from being a passing fad, Advanced Beta strategies are a strong global trend that is here to stay. 40 200 Low Volatility / Equal Weight 20 100 Dividend Fundamental Weight 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Low Volatility / Equal Weight Maximum Diversification Recent Growth in Advanced Beta AUM 2012 2014 bn 30 25 20 0 Enhanced Futures Strategy Maximum Diversification Value Growth 15 10 5 0 Jan Jun Dec Jan Jun Dec Jan Jun Dec 2012 2013 2014 Source: Morningstar. Data as of 31/12/2014 State Street Global Advisors 9
Snapshot: The State of Advanced Beta in Europe Deep Dive on Equity With investors attention clearly heavily focused on the sector, we take a closer look at the Equity category, the largest constituent of Advanced Beta by assets and number of funds. Advanced Beta Strategy 2014 Equity Assets Low Volatility/ Equal Weight Dividend Fundamental Weight Maximum Diversification Value Enhanced Futures Strategy Growth 22.9 bn 22.7 bn 11.8 bn 2.6 bn 1.2 bn 0.5 bn 0.1 bn 83 68 61 13 10 3 8 Equity Funds Source: Morningstar, as of 31/12/14 Global Broad Category: Equity Asset and Fund Numbers by Advanced Beta Strategy 2014 Assets in Bn Market share (%) Rank by Assets Number of funds Market share (%) Rank by Funds Low Volatility / Equal Weight 22.89 37.0 1 83 33.7 1 Dividend 22.69 36.7 2 68 27.6 2 Fundamental Weight 11.85 19.2 3 61 24.8 3 Maximum Diversification 2.60 4.2 4 13 5.3 4 Value 1.17 1.9 5 10 4.1 5 Growth 0.14 0.2 7 8 3.3 6 Enhanced Futures Strategy 0.49 0.8 6 3 1.2 7 Total 61.83 246 Source: Morningstar, as of 31/12/14 A market driven by Equity At End of 2014 246 61.83bn 85 % Number of Funds Assets Market Share
Conclusion Advanced Beta investing may still be considered by some to be at the pioneer stage but over recent years Advanced Beta funds have grown impressively in Europe, both in number and by assets gathered. Given current market sentiment and their recent performance, we expect that Advanced Beta funds will continue to proliferate. Demand for these funds has increased over the last couple of years and looks likely to continue to increase. Equity funds will continue to dominate the landscape but increasingly fixed income products are coming on stream. Expect also, in 2015 to see an increasing presence from new hybrids such as multifactor funds that combine factors such as low volatility, quality and value into one potent, effective package. Advanced Beta has come a long way, in a very short time but it s just the beginning of an exciting period of development for these funds. State Street Global Advisors 11
Snapshot: The State of Advanced Beta in Europe ssga.com The views expressed in this material are the views of the SSGA Investment Management through the period ended 31 December 2014 and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Past performance is not a guarantee of future results. Asset Allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Investing in foreign domiciled securities may involve risk of capital loss from unfavourable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA s express written consent. The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2004/39/EC) and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor s or potential investor s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. This communication is directed at professional clients (this includes eligible counterparties as defined by the Financial Conduct Authority who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. The Advanced Beta solution is a concept for discussion purposes only. The information provided herein does not constitute investment advice and is not a solicitation. It does not take into account any investor s particular investment objectives, risk tolerance, or financial and tax status. Diversification does not ensure a profit or guarantee against loss. Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise bond values and yields usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Investing in commodities entail significant risk and is not appropriate for all investors. Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates. State Street Global Advisors 2015 State Street Corporation. All Rights Reserved. ID2908-EUMKT-3770 0115 Exp. Date: 31/01/2016