Smart beta ETFs: Pension funds taking it slow

speed bump slowDo you want a monkey looking after your money? That was the burning issue investors faced last year following the release of this study from the Cass Business School in London. The researchers at Cass discovered that pointing primates can generate better performance than market capitalization-weighted indexes over decades and decades—and that’s bad news if you’re counting on passive strategies that hug a market cap-weighted benchmark.

Cue the exchange-traded fund (ETF) industry to ramp up a host of new products based on alternative indexes that look at everything but, from alternative growth to momentum to value factors. The idea is to get away from indexes based on the biggest, most expensive multinational companies and to focus on small- and mid-cap companies that trade at lower price-earnings multiples.

The approach is proving particularly effective for investors facing an uneven global recovery. Europe, for example, is one space where a smart beta approach is gaining a lot of traction with investors eager to track the region’s recovery. They allow investors to be more “granular in their choices,” according to David Garff, president of Walnut Creek, Calif.-based Accuvest Global Advisors, speaking to Reuters. Not surprisingly, smart beta is one of the faster growing segments of the global $2.4 trillion ETF space.

However, one segment of investors is proceeding with caution when it comes to smart beta: pension funds. Plan sponsors are sticking to what they know and taking it slow when it comes to smart beta ETFs, according to a recent survey of asset managers by Russell Investments. They’re still unsure how these products fit, and they’re using them as a tactical short-term plan instead of a core long-term position.

But plan sponsors are increasingly using ETFs to dig deeper into markets, and that’s where smart beta products could fit in the future. They are, for example, using country-focused ETFs to go beyond broad indexes and find the markets with greater potential for growth, outside of a larger region. They’re also using them to put regional portfolios together that cut out specific countries (i.e., Turkey).

Bottom line: there is definitely a shakeup happening in the ETF space as plan sponsors expect more from their passive lineup.