Smart beta slow to gain traction among asset managers

If you're hesitant to adopt so-called “smart beta” products — or if you aren't even sure exactly what smart beta means — you aren't alone. A survey of asset managers — mostly pension funds — revealed that while the popularity of smart beta products is growing, these investments don't yet play a major role in most asset managers' portfolios, according to a survey released Monday by Russell Investments. “More and more people are adopting smart beta products, but I wouldn't expect a revolution,” said Rolf Agather, managing director of Russell Indexes. “This will occur at a slow and steady pace during the early days of adoption.” The term “smart beta” is notoriously hard to pin down. In fact, only 15% of North American asset managers surveyed are comfortable with the phrase at all. However, the common thread among most of these funds is a strategy — from equal weighting to fundamental indexing to low volatility — that promises to help investors attain better returns for a given level of risk. (More: The 2 biggest factors driving growth in active ETFs) One reason for smart beta's popularity is that managers are starting to realize that “market cap weighting is just about the worst way to weight stocks,” said David Nadig, chief investment officer at ETF.com. Market capitalization weighting has a tendency to increase investors' exposure to a stock as its price rises, which many smart beta funds strive to avoid. So far, the success of these new funds has been uneven. Only about one-third of survey respondents noted having a smart beta allocation. The products are least popular among organizations with assets under management of $1 billion or less, only 9% of whom use these products. Among those managing $10 billion or more, about half embrace smart beta. Bigger organizations are more likely to have a staff sufficiently large enough to review complex new products, Mr. Agather said. Plus, firms with large asset bases can more easily “dip their toe in the water” with a small allocation to smart beta, he said. Even among smart beta's acolytes, few are relying heavily on the funds. More than 60% of those who use smart beta allocate less than 10% of their portfolios to the products, the survey found. (Related: Smart beta ETFs squeezing 256% from S&P 500) “I think we are seeing that most asset managers are still trying to figure out where these products fit,” Mr. Agather said. “They are taking smaller, tactical allocations rather than big, strategic allocations.” And quite a bit of skepticism lingers. About 20% of asset managers are not interested in even considering the adoption of smart beta. The most common reason cited among this group is that they feel the investment does not have merit. There is often good reason for this sentiment, Mr. Nadig said. Many smart beta strategies could easily be mimicked by simpler, less expensive approaches. Nonetheless, these strategies are poised to proliferate in the coming years, the survey found. The majority of asset managers who use smart beta products plan to increase allocations in the near future. Among those who are currently evaluating the products, more than three-quarters plan to make an allocation, according to the survey results. This isn't surprising, as some smart beta strategies offer potential for risk-adjusted outperformance, Mr. Nadig said. The most prominent example are funds that focus on buying “quality” stocks, based on factors like the company's earnings growth and debt-to-equity ratios. “I don't think that a large group of people are skeptical about smart beta funds as a whole,” Mr. Agather said. “The important thing is to understand each individual strategy and whether it fits into your portfolio.” What distinguishes smart beta as an investment strategy?