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A popular, low-risk investment product is losing its luster as new launches slow down

Key Points
  • "The waterfront has been covered. More and more managers are looking to differentiate on price and fewer and fewer new entrants are making their way to the market," analyst Ben Johnson says about strategic beta investment products.
  • Morningstar data shows that between 2000 and 2018 these types of products exploded in popularity and their assets under management expanded to nearly $800 billion from less than $10 billion.
  • However, market share has stabilized in recent years while the number of new launches drops to 59 in 2018 from 85 the year before.
Traders work on the floor at the New York Stock Exchange, March 22, 2019.
Brendan McDermid | Reuters

CHICAGO — The popularity of so-called strategic beta investment vehicles could be waning as new products launch at a slower pace and pressure to lower fees increases, a Morningstar analyst said Wednesday at the company's annual investment conference.

"The waterfront has been covered. More and more managers are looking to differentiate on price and fewer and fewer new entrants are making their way to the market," said analyst Ben Johnson. "I think we're seeing maturity in this space."

Strategic beta vehicles, also called smart beta, are exchange-traded products that aim to maximize investment returns by reducing risks as much as possible. One example is the Invesco S&P 500 Low Volatility ETF (SPLV), which is made up of stocks that typically have very low volatility, such as Coca-Cola. The fund also owns shares of Aon, a professional services company. Another strategic beta fund, the iShares Edge MSCI USA Quality Factor ETF (QUAL), gives investors exposure to companies with stable earnings growth and low leverage, such as Visa and Lockheed Martin.

These types of products exploded in popularity between 2000 and 2018, Morningstar data shows. In that time, their assets under management expanded to nearly $800 billion from less than $10 billion. Their market share among exchange-traded products also surged to around 20% of all exchange-traded products in that period.

However, market share has stabilized since 2015 while the number of new launches dropped to 59 in 2018 from 85 the year before.

Johnson said increasing pressure to lower fees could be one of the factors keeping new strategic beta products from launching. Asset managers are rapidly slashing fees on mutual funds and exchange-traded funds since high fee levels from the past are now a turnoff for consumers. Last year, Fidelity launched a fund that did not charge any fees.

"Anecdotally, [managers] don't feel like fighting over fees. They have valuable ideas, they have valuable IP, but they don't want to sell it for next to nothing," he said.

Growth in assets under management also slowed to 0.5% in 2018 on a year-over-year basis from 9.7% in 2017.

One area where investors and asset managers could see further growth in products is in the environmental, social and governance space, or ESG. The term refers to investments that could have a positive impact on society. Last year, ESG had record inflows, pushing their assets under management to $89 billion, Morningstar data shows.

"All the things that fall into the ESG bucket certainly have begun to get traction," Johnson said, highlighting the launch of an ESG exchange-traded fund earlier this year. But "I think further adoption is probably further out. Ultimately, that will be facilitated by being able to create a sort of holistic ESG-oriented portfolio."

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Key Points
  • "People [are] taking a more ethical approach to their investing. That has been more tied to environmental issues, primarily in Europe and the United States," says Paul O'Brien, former deputy CIO of the Abu Dhabi Investment Authority, which manages more than $700 billion in assets. "But, really, ethics applies to countries, too."
  • Bloomberg News reported last month that Pharo Management, a UK-based hedge fund, returned $300 million to the Saudi Arabian Monetary Authority after the murder of journalist Jamal Khashoggi at the hands of the Saudi government.