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A Global Guide to Strategic-Beta Exchange-Traded Products
Contents Introduction
A Look at the Numbers
Act 1: The Global Strategic-Beta ETP Landscape 7 Global Summary 8 North America 23 Europe 30 Asia-Pacific 43 Emerging Markets
Act 2: Factors—Theory and Practice
Act 3: A Practical Guide to Analyzing Strategic-Beta Products
Appendix: Strategic-Beta Definitions
Executive Summary
“Smart beta” is an unfortunate name, one that has positive connotations that may not always
be warranted.
What Morningstar deems “strategic beta” is a broad and rapidly growing category of benchmarks
and the investment products that track it.
As of June 30, 2014, there were 673 strategic-beta exchange-traded products, or ETPs, with
collective assets under management of approximately $396 billion worldwide.^1
Strategic-beta ETPs are making inroads against their peers that are benchmarked to more-traditional
indexes. While their market share has been increasing in every region we have examined, they have
made greater inroads in large, more mature markets than they have in smaller, less developed ones.
For example, strategic-beta ETPs accounted for 19% of U.S. ETP assets, but just 1.5% of ETP assets
in the Asia-Pacific region.
The common thread among strategic-beta investment products is that they seek to either improve
their return profile or alter their risk profile relative to more-traditional market benchmarks.
As new products have continued to roll off asset managers’ assembly lines, their sales and
marketing departments have been working tirelessly to position these new models in an increasingly
competitive field.
The result has been a ratcheting up of the level of complexity of the indexes that underlie these
benchmark-based investment products and, in some cases, a growing disparity between how they
are pitched by their sponsors and the actual investment results they produce.
The need to define, measure, and police this space has grown and will continue to grow with time.
At Morningstar, we are positioning ourselves to meet these needs, with the goal of helping investors
make better-informed investment decisions.
This report is split into three “acts.” In the first act, we examine the global strategic-beta ETP
landscape, looking at trends in asset growth, asset flows, product development, and fees on a
region-by-region basis. In the second act, we discuss the “origins” of strategic beta, looking at the
various types of risk that these strategies look to harness and how they manifest themselves in an
investment context. Finally, in the third act, we provide a practical guide to analyzing strategic-beta
ETPs through a number of different lenses that will help investors make more-informed decisions
when considering these products.
- All monetary figures throughout this report are expressed in U.S. dollars unless otherwise stated.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Introduction
“Smart beta,” “alternative beta,” “enhanced indexes,” “quantamental indexes”—at this point, the
list of monikers describing the fast-growing middle of the active-to-passive spectrum extends long
enough to put it just a few syllables shy of making a lunar landing. It’s an arena that has further
blurred the lines between active and passive management (see Exhibit 1), and one that is at the
leading edge of the most recent wave of product proliferation within the global exchange-traded
products landscape.
What Morningstar deems strategic beta is a broad and rapidly growing category of benchmarks and
the investment products that track it. The common thread among them is that they seek to either
improve their return profile or alter their risk profile relative to more-traditional market benchmarks.
In the case of equity products, which account for the overwhelming majority of assets in this arena,
the result is typically one or more factor tilts relative to standard market indexes.
Exhibit 1 Part Passive, Part Active: Strategic Beta Lives in the Middle of the Active-to-Passive Spectrum
Bet Against
Market Portfolio
(Active)
Rules-Based
(Passive)
Market-Cap
Weighted
Actively
Managed
Strategic
Beta
Source: Morningstar Research
As new products roll off asset managers’ assembly lines, their sales and marketing departments
have been working tirelessly to position these new models in an increasingly competitive field. The
result has been a ratcheting up of the level of complexity of the indexes that underlie these
benchmark-based investment products and, in some cases, a growing disparity between how they
are pitched by their sponsors and the actual investment results they produce. Investors are faced
Hortense Bioy, CFA Director of Passive Fund Research Passive Strategies–Europe +44 203-194- [email protected]
Alex Bryan Analyst Passive Strategies +1 312 244- alex.bryan @morningstar.com
Jackie Choy, CFA ETF Strategist Passive Strategies +852 297- [email protected]
John Gabriel ETF Strategist Passive Strategies +1 312 384- [email protected]
Ben Johnson, CFA Director of Manager Research Passive Strategies–Global +1 312 384- ben.johnson @morningstar.com
Samuel Lee Strategist Editor, Morningstar ETFInvestor +1 312 244 7015 samuel.lee @morningstar.com
Tim Murphy, CFA Director of Manager Research Australia +61 2 9276 4436 tim.murphy @morningstar.com
Alexander Prineas Analyst Australia +61 2 9276 4525 [email protected]
Gordon Rose, CAIA, CIIA Analyst Passive Strategies–Germany +49 69 271377 156 gordon.rose @morningstar.com
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
It should be noted that these are merely attribute tags and not new categories, just as we do not
have a “passive” or an “active” category. The portfolios of strategic-beta products exhibit a variety of
investment styles. Our purpose in creating these descriptions is to help investors rigorously analyze
this breed of investments, facilitating comparisons among those with similar strategies as well as
within the context of their traditional Morningstar Category.
A Motley Crew
In delineating the boundaries of the strategic-beta space, we have tried to be as inclusive
as possible, including products that may have a variety of different processes but yield fairly similar
end products, and all of which deviate in some meaningful way from their traditional broad-based
index peers.
Also, it is important to note that our definition differs from some others’ in that we include products
tied to benchmarks that first screen candidates for a variety of attributes (value, growth, and dividend
characteristics, for example) and subsequently weight the eligible securities by their market
capitalization. Others have adopted a more narrow definition that excludes any products based on
benchmarks whose constituents are market-cap-weighted.
Our resulting universe includes a diverse range of products, though there are common elements
among them:
They are index-based investments.
They track nontraditional benchmarks that have an active element to their methodology,
which typically aims to either improve returns or alter the index’s risk profile relative to a
standard benchmark.
Many of their benchmarks have short track records and were designed for the sole purpose of
serving as the basis of an investment product.
Their expense ratios tend to be lower relative to actively managed funds.
Their expense ratios are often substantially higher relative to products tracking “bulk beta”
benchmarks like the S&P 500.
Better Returns, Less Risk?
Having defined the strategic-beta space in very broad terms, Morningstar makes a second cut of the
universe, tagging products on the basis of the overarching strategic objective of their underlying
benchmark. These objectives fall into three buckets: return-oriented strategies, risk-oriented
strategies, and a catch-all “other” classification.
Return-oriented strategies look to improve returns relative to a standard benchmark. Value- and
growth-based benchmarks are prime examples of return-oriented strategies. Other return-oriented
strategies seek to isolate a specific source of return. Dividend-screened or weighted indexes are the
chief examples of this type of return-oriented strategy.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Meanwhile, risk-oriented strategies look to either reduce or increase the level of risk relative to a
standard benchmark. Low-volatility and high-beta strategies are the most common examples of
risk-oriented strategies.
Lastly, “other” encompasses a wide variety of strategies, ranging from nontraditional commodity
benchmarks to multiasset indexes. This second cut allows investors to classify strategic-beta
instruments along very broad lines.
The Devil Is in the Details
The third and final cut involves classifying products with similar strategic objectives at a more
granular level. Here we group products tracking dividend-screened or weighted, value, low/minimum
volatility/variance, nontraditional commodity, and a variety of other benchmarks together. This is
intended to facilitate more-precise comparisons among products with very similar underlying
methodologies. Exhibit 2 outlines our strategic-beta taxonomy in full detail.
Exhibit 2 Morningstar’s Strategic-Beta Taxonomy
Return-Oriented Value Growth Size Momentum Quality Fundamentally Weighted Dividend Screened/Weighted Earnings-Weighted Revenue-Weighted Expected Returns Shareholder Yield/Buyback Multifactor
Risk-Oriented Minimum Volatility/Variance Low/High Beta Risk-Weighted
Other Equal-Weighted Nontraditional Commodity Nontraditional Fixed Multiasset
Source: Morningstar Research
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Act 1: The Global Strategic-Beta ETP Landscape
Global Summary
As of June 30, 2014, there were 673 strategic-beta exchange-traded products, or ETPs, with
collective assets under management of approximately $396 billion worldwide. Strategic-beta ETPs
are making inroads against their peers that are benchmarked to more-traditional indexes. While their
market share has been increasing in every region that we have examined, they have made greater
inroads in large, more mature markets than they have in smaller, less developed ones. For example,
strategic-beta ETPs accounted for 19% of U.S. ETP assets, but just 1.5% of ETP assets in the
Asia-Pacific region.
While regional markets are at varying stages of development, there are some common themes that
cut across geographies. First, dividend screened/weighted ETPs are the most popular grouping of
strategic-beta ETPs in every region we examined. This should come as little surprise when
considered in the context of the prevailing interest-rate environment. Investors around the globe
have piled in to dividend-paying equities, shunning the low (or negative) real yields offered by issues
from developed-markets sovereigns.
There is also a clear positive relationship between the adoption of strategic-beta ETPs and the age of
each region’s ETP market, and its asset-management and financial-services industries more
generally. The U.S. is home to a very large and mature asset-management industry and has the
second-oldest (next to Canada’s) ETP market in the world. Thus, the fact that U.S. strategic-beta ETPs
account for 90% of total assets in this grouping is only natural.
As for fees, strategic-beta ETPs tend to charge expense ratios that are more competitive than their
comparable actively managed peers (though in some cases only marginally so). That said, in many
cases they take a toll many multiples of that levied by their more ordinary passive peers.
Another commonality among the markets we examined is the increasing complexity of the
benchmarks underlying new ETPs. This is part of the natural evolution of the market and one that has
already played out in the slicing and dicing of traditional market-capitalization-weighted exposures
along the lines of region, country, sector, subsector, and so on. As these strategies become
increasingly nuanced, looking to repackage elements of an active manager’s thinking into an index,
investors’ collective due-diligence burden will continue to increase commensurately.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
North America
United States
The U.S. is home to what is far and away the largest and most diverse stable of strategic-beta ETPs.
It is host to 57% of the total number of strategic-beta ETPs, which together account for nearly 91%
of global assets. This should come as little surprise given the overall size and maturity of the
domestic asset-management and financial-services industries. The first generation of strategic-beta
ETPs came to the U.S. market in May 2000. The iShares Russell 1000 Growth (IWF) and iShares
Russell 1000 Value (IWD) ETFs were not only the first but are presently the two largest strategic-beta
ETPs. These funds represented “first generation” strategic beta—introducing systematic style tilts to
a market that was already well-versed in a style-based approach to equity investing. Fast-forward 14
years to June 30, 2014, and strategic-beta ETPs numbered 374 and had collective assets under
management of $359.7 billion.
Exhibit 3 Strategic-Beta ETP Asset Growth (May 2000 Through May 2014)
100
200
300
400
$Billion
Source: Morningstar Direct, Morningstar Research
Grow With the Flow
Growth in strategic-beta ETPs has been driven primarily by new adopters across the investor
spectrum, ranging from individuals to state pension funds. Approximately 70% of the aggregate
growth in strategic-beta ETP assets dating back to May 2000 has come from net new inflows, while
the remaining 30% reflects asset appreciation. In many ways, the U.S. market was well-“primed” for
strategic beta. The Morningstar Style Box, among other things, had popularized the concept of style
investing among U.S. investors by the time the first strategic-beta ETPs were launched in 2000. At
that time, exchange-traded funds had been around for about seven years, though they were still
novel to many investors and being used predominantly as trading vehicles. Also, within the advisor
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Roll Out the Betas
As mentioned previously, the first generation of strategic-beta ETPs delivered fairly straightforward
style tilts. Subsequently, there was a flurry of launch activity from 2005 to 2007, as strategic-beta-
focused ETF providers rolled out full families of more-complex strategies. These included
PowerShares’ roster of Dynamic and RAFI funds, WisdomTree’s suite of dividend-screened/weighted
funds, and First Trust’s AlphaDex lineup. New launch activity hit a lull from 2008 to 2010 thanks
to the global financial crisis, but picked up once again in 2011 as providers moved to cover new
bases (low/minimum volatility/variance strategies, for example). More recently, new launches have
trended toward multifactor strategies, as exemplified by State Street Global Advisors’ new suite of
ETFs tied to MSCI Quality Mix benchmarks and JP Morgan’s first foray into the ETF market, with
JP Morgan Diversified Return Global Equity ETF (JPGE), which tracks the FTSE Developed Diversified
Factor Index.
Exhibit 6 Number of Surviving Strategic-Beta ETPs by Vintage
Year of Launch # of ETPs
2000 16 2001 2 2002 0 2003 6 2004 11 2005 28 2006 64 2007 51 2008 9 2009 7 2010 16 2011 53 2012 42 2013 40 2014 29
Source: Morningstar Direct, Morningstar Research
Simple Tastes
While complexity has been on the rise, investors’ preferences remain fairly plain-vanilla. Classifying
the current roster of U.S. strategic-beta ETPs according to their secondary attributes shows that ETPs
offering exposure to fairly straightforward strategies (value, growth, dividend-screened/weighted)
account for nearly three fourths of strategic-beta ETP assets. Dividend-screened/weighted strategies
have proved particularly popular in the context of a yield-starved investment environment and
investors who are placing a greater emphasis on investment income as they move from the
consolidation stage of their investment lifecycle to the decumulation stage. The popularity of
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
style-based investing and the use of some of these funds for purposes of implementing tactical
factor tilts explain the popularity of standard value and growth funds.
Exhibit 7 Market Share by Secondary Strategic-Beta Attribute
Secondary Attribute % of Assets
Dividend Screened/Weighted 30. Growth 23. Value 23. Multifactor 6. Equal-Weighted 3. Low/Minimum Volatility/Variance 3. Nontraditional Commodity 2. Fundamentally Weighted 1. Nontraditional Fixed Income 1. Momentum 1. Buyback/Shareholder Yield 0. Earnings-Weighted 0. Quality 0. Multiasset 0. Revenue-Weighted 0. Expected Returns 0. Low/High Beta 0.
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014.
Exhibit 8 Ranking of Strategic-Beta ETPs by Secondary Attribute
Secondary Attribute # of ETPs Assets ($) % of Assets
Dividend Screened/Weighted 85 108,590,201,949 30. Growth 33 83,998,669,298 23. Value 37 83,585,361,377 23. Multifactor 72 21,778,583,497 6. Equal-Weighted 19 13,727,068,329 3. Low/Minimum Volatility/Variance 14 11,819,883,577 3. Nontraditional Commodity 35 9,180,759,524 2. Fundamentally Weighted 15 6,546,492,411 1. Nontraditional Fixed Income 9 5,627,371,754 1. Momentum 18 4,297,245,672 1. Buyback/Shareholder Yield 3 3,032,789,608 0. Earnings-Weighted 6 2,904,315,046 0. Quality 10 1,667,511,545 0. Multiasset 4 1,549,221,012 0. Revenue-Weighted 6 804,707,255 0. Expected Returns 3 318,478,265 0. Low/High Beta 4 289,431,603 0. Risk-Weighted 1 8,553,462 —
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Keeping an Eye on Expenses
Interestingly, the fees levied by strategic-beta ETPs are, on average, comparable to or competitive
with those charged by the ETP field at large as well as the universe of ETPs ex-strategic beta. Most
notably, the asset-weighted average expense ratio for equity ETPs across all three of the
aforementioned groupings is virtually identical—in fact, it’s 1 basis point lower for strategic-beta
equity ETPs. Of course, fees should be considered on a case-by-case basis. For example, Schwab US
Broad Market ETF (SCHB), which tracks the market-capitalization-weighted Dow Jones U.S. Broad
Stock Market Index, charges an annual fee of just 0.04%. Schwab Fundamental US Broad Market
ETF (FNDB), which tracks the Russell Fundamental U.S. Index, levies a fee of 0.32%—a much higher
hurdle relative to its more ordinary sibling.
In aggregate, it is clear that across all three groupings—all else equal—investors prefer less pricey
fare, as indicated by the fact that the asset-weighted average expense ratios tend to be lower than
the simple averages. That said, there are clearly some outliers, ETPs of all ilk that charge fees
comparable to those of active managers. Investors should take extra care to assess whether such
tolls are justifiable for an index-tracking product.
Exhibit 11 Fees Under the Microscope
Combined (%)
Equity (%)
Fixed Income (%)
Commodities (%)
Alternative (%)
All ETPs (^) Weighted Average 0.33 0.32 0.26 0.51 0. Simple Average 0.62 0.55 0.34 0.82 0. ETPs Without Strategic-Beta (^) Weighted Average 0.34 0.32 0.26 0.45 0. Simple Average 0.65 0.59 0.33 0.83 0. Strategic-Beta (^) Weighted Average 0.32 0.31 0.37 0.85 1. Simple Average 0.52 0.48 0.38 0.80 1.
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Canada
At the start of 2009, strategic-beta ETFs in Canada had less than $400 million in total net assets
spread across 15 funds. As of June 30, 2014, there were 83 strategic-beta ETFs in Canada with total
net assets of about $7.5 billion. That’s a nearly 19-fold increase in assets under management over a
five-year period.
Exhibit 12 Assets Under Management—Strategic-Beta ETFs in Canada (June 2007 Through June 2014)
2
4
6
8
20
40
60
80
$Billion
Equal- Weighted
Return-Oriented
Dividend Screened/Weighted
Fundamentally Weighted
Growth Momentum Quality Value Low/High Beta
Minimum Volatility/Variance
Risk- Weighted
of SB
ETFs
Risk-Oriented
Source: Morningstar Direct, Morningstar Research
Increased adoption of strategic-beta strategies by Canadian investors is far and away the biggest
driver behind the group’s impressive growth. Over the past five calendar years, net inflows have
accounted for more than 78% of the aggregate growth in strategic-beta ETF assets, with the
remainder being the result of market appreciation.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Exhibit 14 Strategic-Beta ETFs’ Share of Total ETF Assets and ETF Asset Flows
%
2008 2009 2010 2011 2012 2013 2014 H
ETF AUM
ETF Flows
Source: Morningstar Direct, Morningstar Research
History
The first strategic-beta ETF that was introduced to the Canadian market was iShares Canadian Select
Dividend (XDV), which launched in December 2005.
Exhibit 15 Annual Launches of Strategic-Beta ETFs in Canada
Year # ETFs Advisor Class Shares
2005 1 — 2006 8 3 2007 4 2 2008 2 1 2009 7 2 2010 4 — 2011 4 1 2012 23 4 2013 12 5 2014 H1 18 8
Source: Morningstar Direct, Morningstar Research
A few months later, in February 2006, Claymore Investments Inc. launched a fundamentally weighted
strategy that is today known as iShares Canadian Fundamental Index (CRQ). There was a name
change following BlackRock Canada’s acquisition of Claymore Canada from Guggenheim Partners
LLC in the first quarter of 2012. The strategy remains unchanged; the fund continues to track the
FTSE RAFI Canada Index.
©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
Later that year, in September 2006, Claymore followed up with two more strategic-beta ETFs: a
U.S.-focused RAFI and a domestic dividend strategy. Today, those ETFs are known as iShares
US Fundamental (CAD-Hedged) Index (CLU) and iShares S&P/TSX Canadian Dividend Aristocrats
Index (CDZ).
Claymore built a solid business in Canada by focusing on alternative indexing strategies rather than
traditional market-cap-weighted fare. In the ensuing years, the firm introduced a range of other RAFI
index ETFs. The firm’s U.S.-based parent company already had similar products in its home market;
Claymore Canada was successful in leveraging the parent company’s existing relationship with
Research Affiliates to bring its strategic-beta strategies across the border.
iShares Canadian Value (XCV) and iShares Canadian Growth (XCG) launched in November 2006 to
little fanfare, as style investing isn’t prevalent in Canada.
The next phase of the strategic-beta movement in Canada came as new entrant BMO Asset
Management introduced a series of equal-weight industry and sector ETFs in late 2009 and
mid-2010. The funds were well-received because they offered investors a way to limit concentration
risk. It was not uncommon for the market-cap-weighted peers to stake around 20% of assets in each
of the top two or three firms.
In the summer of 2011, another U.S.-based provider that was carving out its niche as a provider of
“next generation” index strategies expanded to the North. PowerShares Canada joined the fray by
introducing its own domestic dividend strategy and RAFI-tracking ETFs. It also introduced the
country’s first “low-volatility” strategy, after its U.S.-based parent had tremendous success attracting
assets into the strategy stateside.
In early 2012, Canada saw another new ETF provider enter the fray with its own lineup of strategic-
beta ETFs. First Asset Investment Management brought two dividend strategies to market—one
domestic and the other U.S.-focused. It also launched “value” and “momentum” strategies^4 covering
the Canadian market. The momentum strategy was the first of its kind in Canada, and, until today,
First Asset is the only ETF provider that offers exposure to this factor.
By this time, the strategic-beta movement was in full effect in Canada. A steady stream of strategic-
beta ETFs hit the market over the next couple of years.
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©20 14 Morningstar. All rights reserved. The information, data, analyses, and opinions contained herein (1) are proprietary to Morningstar, Inc. and its affiliates (collectively, “Morningstar”), (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be accurate, complete, or timely. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses or opinions or their use.
While dividend screened/weighted funds are way out in front, claiming nearly half of all strategic-
beta ETF assets in Canada, equal-weighted and fundamentally weighted are in a tight race for
second and third. The equal-weighted group is bolstered by BMO’s portfolio of sector and industry
ETFs, while the fundamentals group is driven by the iShares and PowerShares ETFs that track the
RAFI benchmark.
Exhibit 18 Strategic-Beta ETF Assets Ranked by Secondary Attribute
Secondary Attribute # of ETFs AUM $ Market Share %
Dividend Screened/Weighted 20 3,525,372,516 47. Equal-Weighted 10 1,564,818,159 21. Fundamentally Weighted 15 1,355,117,294 18. Value 7 389,853,639 5. Minimum Volatility/Variance 7 242,672,721 3. Momentum 6 177,201,190 2. Quality 1 118,159,955 1. Risk-Weighted 14 42,381,719 0. Growth 1 30,000,045 0. Low/High Beta 2 5,685,721 0.
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014.
By Firm
Thanks in large part to its acquisition of Claymore, iShares is the clear leader in the strategic-beta
ETF space. In fact, about 60% of iShares’ strategic-beta AUM comes from former Claymore ETFs.
BMO is a distant second with its 10 equal-weighted industry ETFs and a “quality” Europe fund. BMO
makes the list by definition, but it’s worth noting that because of their extremely narrow focus, many
of its equal-weighted ETFs are treated more as single-stock replacements than broad market or beta
products.
For instance, the firm’s largest strategic-beta ETF (and the third largest in the country) is BMO S&P/
TSX Equal Weight Banks ETF (ZEB), which is simply an equal-weight portfolio of the six major
Canadian banks. Some notable omissions include BMO’s domestic and U.S. low-volatility and
dividend strategies. While these funds are designed to follow rules-based strategies, they do not
track a published public benchmark. Therefore, by definition, we consider those ETFs to be actively
managed. If included, they would add another $900 million to BMO’s strategic-beta asset tally (an
increase of more than 50%).
First Asset has attracted attention (and assets) recently based on the stellar performance of a few of
its strategic-beta funds, namely the firm’s domestic value and momentum funds, which have
consistently outperformed their category peers since their inception.
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Exhibit 19 Strategic Beta ETF Assets by Provider
Rank Firm Name # of ETFs AUM $ Market Share %
1 iShares 27 4,433,514,487 59. 2 BMO Asset Management Inc. 11 1,682,978,114 22. 3 First Asset Investment Management Inc. 32 670,591,977 9. 4 PowerShares Canada 8 461,986,526 6. 5 Vanguard Investments Canada Inc 3 175,079,680 2. 6 First Trust 2 27,112,176 0.
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014.
By Fund
The two oldest dividend ETFs in the country remain the largest strategic-beta funds in Canada by a
relatively wide margin. Exhibit 20 lists the top 15 strategic-beta ETFs in Canada, as of June 30, 2014.
Exhibit 20 Top 15 Largest Strategic-Beta ETFs in Canada
Name Ticker Secondary Attribute MER % AUM $
Market Share %
iShares Canadian Select Dividend XDV Dividend Screened/Weighted 0.55 1,415,107,846 18. iShares S&P/TSX Cdn Div Aristocrats CDZ Dividend Screened/Weighted 0.66 991,160,126 13. BMO S&P/TSX Equal Weight Banks ETF ZEB Equal-Weighted 0.62 600,806,719 8. iShares US Dividend Growers(CAD-Hdg) CUD Dividend Screened/Weighted 0.65 359,855,003 4. BMO Equal Weight REITs ETF ZRE Equal-Weighted 0.62 316,455,847 4. iShares Canadian Fundamental CRQ Fundamentally Weighted 0.71 231,904,613 3. iShares International Fundamental CIE Fundamentally Weighted 0.72 224,575,113 3. iShares US Fundamental (CAD-Hedged) CLU Fundamentally Weighted 0.72 220,071,581 2. BMO Eq Weight US Banks Hdgd to CAD ETF ZUB Equal-Weighted 0.40 213,057,517 2. BMO Equal Weight Utilities ETF ZUT Equal-Weighted 0.62 195,868,878 2. FirstAsset Mstar Canada Value ETF FXM Value 0.68 190,023,753 2. iShares US High Div Equity C$-Hedged XHD Dividend Screened/Weighted 0.33 140,480,890 1. iShares US Fundamental CLU.C Fundamentally Weighted 0.71 127,983,631 1. PowerShares Fdmt HiYld Corp Bd CAD H ETF PFH Fundamentally Weighted 0.67 123,072,314 1. FirstAsset Mstar Canada Momentum ETF WXM Momentum 0.68 122,373,427 1.
Source: Morningstar Direct, Morningstar Research. Data as of June 30, 2014.
