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Passive perspective: Smart beta comes at a price

Unlike plain vanilla trackers, charges on factor-based ETFs have held up in recent years. Could that be about to change?

Passive perspective: Smart beta comes at a price

If a price war is happening in exchange-traded funds (ETFs), nobody has told the makers of smart beta funds. A survey of 21 asset managers and 11 investment banks, representing more than 2,200 factor strategies across six asset classes, suggests fees have hardly changed in the past three years.

According to the 2017 Systematic Factor Market Review, by consultancy MJ Hudson Allenbridge, the average fee for an asset manager’s long-only smart beta fund is 0.47%. And fees here range from 0.11% to 1.5%.

For smart beta funds run by investment banks, the average fee is 0.51%, with a high of 1.5% and a low of zero. With zero-charging funds, banks earn revenues from sources such as trade-execution spreads.

Compare and contrast

These numbers compare favourably with conventional active funds. The June 2017 ongoing charges figure (OCF) of around 0.9% for active funds.

But these are all considerably above the average clean cost of around 0.15% noted by the FCA for plain index trackers. And in the US, Schwab, iShares and SPDR offer their cheapest ETFs at a wafer-thin three basis points.

Smart beta fees seem to have faced little pressure in recent years. ‘Compared with our 2014 survey, average fees for asset-manager products have remained essentially constant,’ observed Antti Suhonen and Brendan Campbell of MJ Hudson Allenbridge. ‘For the investment banks, excluding [an] outlier, we report a 10 to 15 basis point reduction in the average fees across the strategies.’

So why have prices held firm? One explanation may lie in the target audiences for these types of strategies. When asked where new allocations to smart beta would come from, providers felt the largest source would be investors replacing previous commitments to hedge funds.

Here, smart beta clearly offers competitive prices even at current levels. Indeed, the average management fee for hedge funds launched in 2016 was 1.51%, according to data firm Preqin.

Shifting perceptions

But as recently as 2014, hedge funds redemptions were viewed as a relatively unimportant source of new money for smart beta. ‘This again suggests that alternative beta products are expected to continue to gain market share from embattled hedge funds, which continue to be perceived by investors as expensive,’ stated Suhonen and Campbell.

Nevertheless, there are some grounds for hope smart beta costs may fall over time. In fact, when providers were asked to indicate the main benefits of smart beta, both asset managers and investment banks highlighted low fees.

Indeed, ‘low fees compared to active management’ had increased the most in importance since the 2014 survey. ‘No doubt [this is] in part due to the increased amount of negative press associated with hedge-fund fees over the past few years’, reckoned Suhonen and Campbell.

Goldman Sachs has already got in on the act. In September last year, its US asset management arm announced a new equal-weighted US large cap smart beta ETF with a fee of just 9 basis points. The start of a price war, perhaps?

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