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The Number of Strategic-Beta ETPs Continues to Mushroom

New funds are coming to market at a record pace, complexity is on the rise, and fees are under pressure.

Ben Johnson, 09/28/2016

The following is an excerpt from our annual "Global Guide to Strategic-Beta Exchange-Traded Products." You can find the full report here.

Two years ago, we introduced our naming convention and taxonomy for the fast-growing universe of strategic-beta exchange-traded products, or ETPs. The goal of our initial guide was to help investors to better define, measure, and analyze this diverse group of passively managed investment products that make active bets against their broad, market-cap-weighted predecessors. In this year's guide, we provide an update on the state of the global strategic-beta ETP landscape.

One year on, the space has continued to grow faster than the broader ETP market and the asset-management industry as a whole. Growth has been driven by new cash flows, new launches, and the entrance of new players--some of which are traditional, dyed-in-the-wool active managers. We expect these trends will continue and may ultimately accelerate as newer ETPs tracking new and unproven benchmarks season and more new entrants make their way into the market. This process of growth and maturation will ultimately lead to a culling of the herd, which has already begun in some geographies, albeit to a limited extent. An increasingly crowded and competitive landscape will also put pressure on fees. We have already seen instances of aggressive fee reductions for strategic-beta ETPs. We anticipate that cost competition in this space will become more prominent in the years to come.

The U.S. Strategic-Beta ETP Landscape
The United States is home to what is far and away the largest and most diverse stable of strategic-beta ETPs. It is host to 54% of the total number of strategic-beta ETPs, which together account for 89% of global ETP assets. This should come as little surprise given the overall size and maturity of the domestic asset-management and financial-services industries. The first strategic-beta ETPs came to the U.S. market in May 2000. IShares Russell 1000 Growth IWF and iShares Russell 1000 Value IWD were not only the first but are presently the two largest strategic-beta ETPs. These funds represented "first-generation" strategic beta--introducing systematic style tilts to a market that was already well-versed in a style-based approach to equity investing. Fast forward 16 years to June 30, 2016, and strategic-beta ETPs numbered 608 and had collective assets under management of $489.8 billion.

Grow With the Flow
Growth in strategic-beta ETPs has been driven primarily by new adopters across the investor spectrum, ranging from individuals to state pension funds. Approximately 79% of the aggregate growth in strategic-beta ETP assets dating back to May 2000 has come from net new inflows, while the remaining 21% reflects asset appreciation. In many ways, the U.S. market was well-"primed" for strategic beta. The Morningstar Style Box had popularized the concept of style investing among U.S. investors by the time the first strategic-beta ETPs were launched in 2000. At that time, ETFs had been around for about seven years, though they were still novel to many investors and used predominantly as trading vehicles. Also, within the advisor space, there were pockets of familiarity with the concepts of factors and risk premiums, owed in part to a rapidly growing and loyal army of Dimensional Fund Advisors [1] converts who were well-versed in size, value, and momentum.

Growth in assets under management in strategic-beta ETPs has outpaced that experienced by the broader ETP industry. As such, strategic-beta ETPs' share of the overall ETP marketplace has climbed to approximately 21% as of the end of June 2016 from nil in 2000--though these ETPs' share of the overall market slipped modestly in 2016.

Ben Johnson is Morningstar’s Director of European ETF Research.

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