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If passive is all about low cost, why isn’t smart beta cheaper?

If passive is all about low cost, why isn’t smart beta cheaper?

If there is an ETF price war happening, nobody has told the purveyors of smart-beta funds.

A new survey of this community, comprising 21 asset managers and 11 investment banks representing more than 2,200 individual systematic factor strategies across six asset classes, suggests that fees have hardly changed over 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 product is 0.47%, with a range from 0.11% to 1.5%.

For smart-beta funds operated by investment banks, the average is 0.51%, with a high of 1.5% and a low of zero where banks earn revenues from trade-execution spreads for example rather than traditional fees.

Still better than active ...

These numbers compare favourably with conventional active funds – the FCA study of the asset-management industry reported an average clean ongoing charges figure of around 0.9% for them on an asset-weighted basis.

However they are both considerably above the average clean cost of approximately 0.15% for plain index trackers noted by the FCA. In the US, Schwab, iShares and SPDR all offer their cheapest ETFs at a measly 3 basis points.

Smart beta fees appear not to have come under much pressure over the past few years.

‘Compared to 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 10-15 basis point reduction in the average fees across the strategies.’

... and better than hedge funds

So why have prices held firm? One explanation may lie in the target audiences for these types of strategy.

When asked where they expected new allocations to smart beta to come from, providers felt the most important source of inflows would be investors replacing previous commitments to hedge funds with factor-based products.

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

As recently as 2014, however, redemptions from hedge funds 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.

There are nevertheless some grounds for hope that smart-beta costs may fall over time. First, when providers were asked to indicate what they perceived to be the main benefits of smart beta, both asset managers and investment banks highlighted the importance of low fees.

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

Second, the pair argued that asset managers in particular had an incentive to keep costs down.

‘While asset-manager remuneration was nearly always derived solely from their headline management fees, it is important to note that the strategies will also incur transaction costs that should be considered when comparing the overall cost to their investment-bank peers,’ they said.

 

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