The factor index market has plenty of room for growth

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Factor-based investment products, including smart beta indices, continue to gain market share relative to actively-managed funds and other passive indices.

As such, some commentators are beginning to question whether this trend is sustainable and whether the smart beta index market is nearing saturation.

But based on allocations towards factors, smart beta and risk premia indices remain underrepresented relative to cap-weighted funds.

Given the uncertainty surrounding global markets, indices targeting the low-volatility factor have been highly popular among investors this year.

Yet, flows into minimum-volatility strategies account for a mere four basis points of the underlying market value of the stocks they hold, FA magazine quoted Holly Framsted, of BlackRock’s iShares smart beta team, as saying this month.

Considering that the value factor has been actively exploited for decades, it would make sense that other, more recently-identified factors such as minimum volatility have room to play catch up.

And despite recent inroads, the value of the factor-index market still pales in comparison to the size of the broader index industry.

Further, the factor-index market is yet to meaningfully penetrate the fixed-income space, which presents a significant opportunity given the size of the fixed-income market.

However, the growing number of products makes it more and more difficult for investors to find, test and harness the best available strategies for their needs.

There are already more than 1,000 smart beta ETFs on the market, with new providers regularly entering this space.  This number also excludes the OTC market for these products.

Fee compression

Once clear consequence of the proliferation of smart beta and risk premia products is the rapid decline in fees, spurred by the growing number of providers and by investors’ demands for lower costs in the low return environment.

While multifactor indices are slightly more expensive than single-factor ones, fees on multifactor funds are also likely to fall as these indices continue to gain favour among investors.