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Smart Beta ESG - The Next Big Thing in Asset Management?

Posted on September 28, 2018

Doug Morrow
Doug Morrow
Director Head of Portfolio Research

Smart beta is all the rage these days. According to data from Morningstar, global assets under management in smart beta strategies hit USD 1tn last year, up from USD 136bn in 2007.[i]

At the same time, investors have been piling assets into environmental, social and governance (ESG) strategies: global ESG assets under management have been estimated at USD 23tn, up 76% from 2012.

Smart beta and ESG may be two of the hottest trends in investment management, but little research has been done to understand how, if at all, these investment styles are mingling with each other.

To shed light on this question, we recently teamed up with Aberdeen Standard Investments and Oxford University on one of the world’s first dedicated smart beta ESG research projects. We consulted 85 investors across 21 countries and asked them pointed questions about their use of, and plans for, smart beta ESG – investment strategies that provide simultaneous exposure to risk premia and ESG criteria.

Early days for smart beta ESG

Our study reveals three key findings about smart beta ESG. First, and perhaps unsurprisingly, it’s early days for such strategies. Just 24% of investors reported a current allocation to smart beta ESG, with regional adoption rates ranging from 32% (Europe), to 19% (North America) and 11% for Asia-Pacific (APAC) investors. By any measure, smart beta ESG remains a highly specialized investment proposition.

Are any of your assets currently using a smart beta ESG strategy?

Negative screens predominate

Second, investors are using three broad approaches to implement smart beta ESG. The most common (62% of smart beta ESG strategies) is negative screens. Examples would include extending a screen on controversial weapons companies to smart beta mandates, dedicated funds or internally managed portfolios.

Another widely used technique (31% of smart beta ESG strategies) is what we termed “ESG metrics.” This approach entails blending conventional factors, such as value and momentum, with ESG metrics that have been found through quantitative testing to add incremental financial value. Investors in this camp largely cited environmental and corporate governance data.

The last approach is climate tilts. This specialized approach (about 7% of smart beta ESG strategies) involves adjusting the final weight of companies in a factor index based on climate change-related metrics, such as carbon emissions.

Lots of action behind the scenes

Finally, despite the low pick up of smart beta ESG, our research suggests that a substantial amount of research and testing is taking place behind the scenes. Nearly one-quarter (21%) of investors said that they expect to increase their allocation to smart beta ESG over the next one to two years.

Do you expect to increase your allocation to smart beta ESG strategies in the next 12-24 months?

Conclusion – more innovation expected

While decidedly nascent today, smart beta ESG could become the next big thing in the asset management world, as investors move to differentiate their smart beta offerings and pick up on the growing risk/return benefits of ESG integration. It is certainly an evolving space that we expect to monitor closely going forward.


[i] Morningstar uses the phrase “strategic beta,” which is slightly more expansive than what is typically referred to as “smart beta”.

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