The Intelligent ETF

mouse and maze_edited-1Pension giant CalPERS announced a few weeks ago that it’s reviewing its investment beliefs, challenging the pension industry’s beliefs about the value of active management. The pension fund, which oversees about US$255 billion in assets, has intimated that it’s considering shifting to an all-passive portfolio and bringing investment management in-house, a move that would save the fund about US$1 billion a year in fees. Considering it’s the second largest pension fund in the U.S., this is huge news. Will CalPERS do it? Maybe not. But the fact that it is considering such a move is a big deal in the pension world. After all, if it turns out to be good enough for CalPERS, others could soon follow.

The fact is, more and more plan sponsors are turning to passive investments for at least a sliver of their equity portfolio, often using exchange-traded funds (ETFs) to manage transitions or add liquidity. But what if ETFs could give better beta?

Enter smart beta ETFs, products that fall somewhere between active and passive investing and let investors tilt weightings in a benchmark index to suit their preferences. For plan sponsors looking for exposure to certain market segments, ETFs with a smart beta twist would allow them to factor in things such as momentum or volatility over and above the main index. This article in Reuters cites data from Towers Watson that says at least US$20 billion fund assets the firm tracks are invested in smart beta strategies, with early adopters such as Danish fund PKA, the Dutch PNO Media fund and Britain’s Wiltshire County Council fund leading the pack.

The ETF industry around the world is eager to respond to this growing need—smart beta products are popping up all over the place. In Canada, however, Yves Rebetez at ETF Insight says we have a long way to go. “Thus far, in Canada, we haven’t yet witnessed the same level of responsiveness…seen in the U.S. low-volatility segment of the ETF industry,” he writes.

But one area where I think the smart beta space could get very interesting is low volatility, especially in emerging markets where many plan sponsors already have ETF allocations and where concerns over volatility are high right now. Low volatility exposure to the U.S. could also be compelling if the price is right (especially as geopolitical hot potatoes such as North Korea continue to rattle markets).

That added layer of active offered by smart beta ETFs might just be enough to get plan sponsors to go a little more passive in the future….

This article originally appeared on BenefitsCanada.com.