June 19, 2015 / 1:35 PM / 4 years ago

Popularity of "smart" funds push fees to record lows

* “Smart” fund launches surge 60 pct in Jan-May

* Fees for investors drop to record lows

* Lyxor partners with J.P. Morgan for such funds

By Atul Prakash and Nishant Kumar

LONDON, June 19 (Reuters) - Launches of investment funds that mimic strategies used by active managers have surged 60 percent over the past year to cater for growing demand, with average fees hitting record lows.

Such “smart-beta” funds use formulas to decide when to buy and sell stocks and bonds on a semi-regular basis, against funds blindly tracking an underlying index or those being actively managed on a daily basis.

Fund tracker Morningstar estimates the sector has quadrupled assets to about $400 billion since 2010. These products are also known as strategic beta, advanced beta or factor-based funds.

Analysts said inflows might fluctuate in the short-term on concerns over Greece and a U.S. rate hike, but the underlying trend was likely to remain strong due to their focus on long-term trends like high dividends and low volatility.

Industry data shows 74 such funds were launched globally in the January-May period, a record for the first five months of a year, against 45 in the period in 2014. They made up half of all the exchange-traded fund (ETF) launches in May 2015, according to data from financial information provider Markit .

“We started investing in factor-based funds two years ago and now about one-fifth of our total ETF allocation goes to these funds,” said Lorne Baring, managing director of Geneva-based B Capital Wealth Management.

“It is very useful to tilt a portfolio towards the style an investor would like such as growth and value,” he added.

“Costs are definitely coming down. A large amount of cash entering the ETF universe means the issuers get more scale and can afford to drop their fees further.”

Data shows the average total expense ratio (TER) — costs for operating a fund including management fees and other expenses — was about 44 basis points (BPS) in 2014, with 12 BPS being the minimum, against an average of 55 BPS in 2013.

Active equity fund managers typically charge between 100 to 200 BPS. On the other hand, some passive ETF providers tracking an index charge as low as 5 to 10 BPS, fund managers said.

NOTE OF CAUTION

Lyxor ETF, which has 50 billion euros ($56.5 billion) in assets under management, said on Friday it is partnering with J.P. Morgan to launch a new range of “smart-beta” funds.

The growing popularity of these funds has caught the eye of regulators in Europe and in the United States who are looking at their potential risks.

“With any industry that’s growing this fast, you want to be careful that you’re making sure the products being brought to the market are well thought out,” said Bill Tilford, head of quantitative investments at RBC Global Asset Management.

Edmund Shing, global equity fund manager at BCS Asset Management, which allocates three-quarters of its total ETF budget to such funds, said certain strategies like mid-caps and low volatility often outperform over time, but many other investment styles may not work that well.

“You are getting a lot of ‘me too’ launches as issuers are trying to stretch the universe by offering strategies that are more marginal now. I have doubts about their outperformance.” (Additional reporting by Simon Jessop; Editing by Keith Weir)

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