Markets

Can Goldman Dominate the Smart Beta ETF Industry?

The ETF industry continues to grow and evolve. More than 200 exchange traded products have been launched in the US this year, taking the total number of products to 1,777 and assets under management to $1.96 trillion.

Last week, Goldman Sachs made their entry into the ETF industry with the launch of their Smart Beta ETF-- ActiveBeta US Large Cap Equity ETF ( GSLC ) . The fund will charge 9 bps in annual expenses, same as that being charged by the most popular ETF in the world, the SPDR S&P 500 ETF ( SPY ) and much lower compared to average fee of 38 bps for US Large Cap Smart Beta ETFs.

This ETF was the first in a series of smart beta ETFs that will track Goldman Sachs's proprietary factor based indexes. Today, they launched their second product in the series- Goldman Sachs ActiveBeta Emerging Markets ETF (GEM) , which comes with a reasonable fee of 45 bps. (Read: 5 Smart Beta ETFs to Beat the Choppy Market )

What is Smart Beta? Is it the Future of the ETF Industry?

The ETF industry has traditionally been dominated by products based on market capitalization weighted indexes that are designed to represent the market or a particular segment of the market. They provide a low-cost, convenient and transparent way of replicating market returns.

But many investors have realized that capitalization weighted indexes are not the most efficient way of investing, at times. In fact, research shows that even random weighting strategies like--monkey throwing darts--consistently outperform cap-weighted indexes.

(Picture Source: The Economist)

On the other hand, most investors have been disappointed with the performance of active managed funds. Smart beta strategies seek to combine the best of active and passive investing i.e. outperforming the market while keeping costs low. And, by following rules based methodologies, they remain transparent and simple to understand.

In simple words, 'Smart Beta' can be defined as an 'advanced' or 'enhanced' form of index investing. This space offers a number of choices to investors, starting from simplest equal-weighting. Fundamental weighting assigns weights to stocks based on their fundamental characteristics such as revenue/earnings, cash flow and value. Volatility/momentum based weighting methodologies favor least volatile/highest momentum stocks. (Read : Which Low Volatility ETFs will Protect Your Portfolio )

While not so popular with retail investors yet, smart beta strategies have already become very popular with institutional investors. In a recent report, Moody's described smart beta as "the next battle ground for asset management dollars."

What's Inside Goldman's ActiveBeta Index?

Per Goldman Sachs, their proprietary index is based on four well-established attributes of performance-good value, strong momentum, high quality and low volatility. Values are calculated for each factor for every stock in an index universe and then used to rank the stocks by each factor. Stocks whose factor scores are above the cut-off score are overweighed and those with factor score below the cut-off score are underweighted. Indexes are rebalanced quarterly. (Read: Best ETF Strategies to Survive Market Turmoil )

Their large cap ETF has a 10 bps management fee, other expenses of 14 bps and then a fee waiver of 15 bps. Per Goldman, waivers and expense limitations will remains in place through at least September 14, 2016.

Can Goldman Succeed?

The US ETF industry is dominated by three big players-BlackRock, Vanguard and State Street-which manage almost 80% of industry assets.

Goldman is trying to break into the industry by providing "low-cost, high- quality market exposure." While smart beta space is becoming increasingly popular, ETFs following those strategies did not come cheap so far. Low expenses certainly give Goldman a competitive advantage in the industry that has a lot of potential.

The Bottom Line

Rising competition in any industry ultimately benefits customers. That applies to the ETF industry as well. In the past few years, surging popularity of ETFs has led to increasing number of products being launched and fees being slashed. With Goldman smart beta ETFs, investors now have an opportunity to get smart beta exposure at a low cost.

While smart beta ETFs promise to beat the market, not all of them have done so. Before investing in smart beta ETFs, it is important for investors to understand the strategy or methodology and how that particular strategy fits within their overall portfolio strategy. ETFs based on rule based, transparent methodologies with reasonable expenses are usually better than those following very complicated strategies.

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GOLDMAN ACTBETA (GSLC): ETF Research Reports

SPDR-SP 500 TR (SPY): ETF Research Reports

ISHARS-MS US MV (USMV): ETF Research Reports

VANGD-SP5 ETF (VOO): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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