Fast-growing 'smart' funds in regulators' sights

Thu Mar 26, 2015 10:57am EDT
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By Nishant Kumar and Simon Jessop

LONDON (Reuters) - Funds that mimic strategies used by active managers for a fraction of the cost could be forced to carry a health warning by regulators who are concerned they may pose greater risks than are being disclosed.

The so-called "smart-beta" funds use formulas to decide when to buy and sell stocks and bonds on a semi-regular basis as opposed to blindly tracking an underlying index or being more actively run on a daily basis.

Fund tracker Morningstar, which calls the funds 'strategic beta', estimates the industry has quadrupled assets to near $400 billion since 2010. Add private mandates and the total is nearly $1 trillion, money manager Lyxor estimates.

The reason is clear. "Smart" funds can charge between a quarter and half the fees of actively managed funds.

However, their popularity has now caught the eye of regulators in Europe and in the United States who are looking at the potential risks they pose, which could lead to new rules and greater disclosures.

The U.S. market watchdog said it would "review" the market this year to see how market volatility affects the funds' performance and regulators in the European Union flagged additional concerns with how the funds are constructed.

The funds shuffle holdings to capture the replicable parts of a strategy which don't involve a manager's particular skill or emotional bias, a kind of half-way house between a passive and actively managed fund.

That could mean, for example, buying high-dividend-yielding stocks, selling overvalued and buying undervalued stocks or re-creating the trades of certain hedge funds.   Continued...

Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall July 16, 2010. REUTERS/Brendan McDermid