Strategic Beta ETFs: Active or Passive?

Nearly two-thirds of ETF issuers claim to position strategic beta as a replacement for passive ETFs, but nearly two-thirds of advisers who are using strategic beta report replacing active mutual funds.

The latest Cerulli Associates reporting speaks of a fundamental “misalignment between ETF issuers and advisers on the use and implementation of strategic beta.”

Researchers warn that financial advisers’ implementation of strategic beta “differs from how issuers are advocating advisers use the products.”

“Adviser use of strategic beta seems to be more focused on the notion of mitigating risk versus generating alpha,” states Jennifer Muzerall, associate director at Cerulli. “Just more than 60% of issuers assert they are positioning strategic beta to generate alpha, whereas the most-cited reason why advisers are using strategic beta is for downside risk protection.”

Strategic beta can achieve both investment objectives, but issuers’ messaging may not be resonating with advisers, Muzerall explains.

“Our findings from our latest ETF report reveal a huge education gap that issuers need to address,” continues Muzerall. “Issuers need to continue to develop their message to help advisers understand the benefits and uses of strategic beta. Cerulli’s research indicates that ETF issuers have a long way to go to increase strategic beta adoption among advisers.”

Much of the Cerulli analysis is written for the asset manager audience, but it shows how advisers have “turned to using ETFs as ‘building blocks’ within their portfolios and are attempting to generate alpha at the asset allocation level.” In other words, they are using ETFs for their low-cost beta exposure.

“Though performance has historically not been the biggest concern for advisers, it actually ranks highest among the attributes advisers consider when selecting an ETF,” Cerulli finds. “As ETFs continue to move away from being passive beta exposures, and more strategic beta and actively managed ETFs come to market, performance will become a bigger focus for advisers and issuers alike.”

Cerulli further reports how advisers who “are heavy ETF users and rely on investment models” are not directly making the underlying investment decisions: “Examples of these types of advisers would be wirehouse advisers who are using home-office ETF investment models.” This arrangement puts the emphasis on home-office decisionmakers, Cerulli explains.

Among advisers using ETFs, 57% say their usage rates are “always influenced by their own investment decisions,” while 41% of advisers are relying on “some sort of outside influence for their ETF use, whether it be their firms’ ETF model portfolios or firms’ recommended lists.”

“As more advisers eventually move to model structures to increase their efficiency, ETF issuers that had built out relationships with home-office broker/dealer teams for early product approval will be the beneficiaries,” Cerulli concludes.

These finding are taken from the report, “U.S. Exchange-Traded Fund Markets 2017: Differentiating Strategies for Sustained Growth.” Information about obtaining Cerulli research is available here