The significant rise in the usage of smart beta ETFs within the past two years has been driven by investor desire to improve performance and manage risk, according to a new survey from the EDHEC-Risk Institute.

Now in its tenth year, the EDHEC European ETF and Smart Beta Survey shows that among participants the usage of ETFs in equity and bond strategies has risen to 91% and 65% in 2016 compared with 45% and 10% respectively in 2006.

The survey also found that over two-thirds or 67% now invest smart beta ETFs, up from 49% in 2014.

Director of the EDHEC-Risk Institute Lionel Martenelli says the survey confirms that transparency and the possibility of making explicit choices when it came to risk exposure were key driver behind the growing appetite for smart beta.

The survey found that 75% of respondents agreed with the assertion that smart beta products allowed for significant potential for outperformance while the opportunity to gain such exposure was the most significant motivation for adopting smart beta investing.

But Martenelli adds: "At the same time, the industry yet has to make progress on offering better insights into risks and more flexibility to allow investors to fully exploit the potential of smart beta strategies."

The survey of 211 ETF and smart beta investors found that 89% of respondents wanted to see full transparency of methodology and risk analytics, and suggested that a lack of transparency was the second most important hurdle to them increasing their smart beta investments. Of those that use smart beta strategies, two-thirds said they have 20% or less exposure to smart beta with only 10% of the investors who use such strategies investing more than 40% of their total investments in smart beta.

When it comes to the mechanics of smart beta investment, the survey found that the 64% of respondents favoured passive strategies that replicate smart beta indices while 44% also used active solutions which included a significant amount of discretion.

These are preferred because of their reactivity and dynamic qualities, with 68% of respondents saying that the ease of changing portfolio allocation was a top priority. For those favouring the replication route, it was for reasons that passive strategies are chosen overall, namely costs (70% of respondents), transparency of methodology (68%) and availability of information (68%).

Increasing interest in fixed income

In terms of expectations for future smart beta product development, a majority saw fixed income as one area where they would like to see an expansion of products while there was also enthusiasm for alternative asset classes including commodities and currencies.

As the report states: "There is still a lack of products when it comes to asset classes other than equity investment, and this lack is particularly critical for the fixed income asset class that is largely used by investors."

Alongside the demand for more customised solutions that can help with specific investor objectives, the report suggested that the development of new products in fixed income and alternative asset classes would likely lead to the wider adoption of smart bets solutions.

As for overall ETF developments, 34% of survey respondents were keen on seeing the further development of emerging market equity ETFs while 33% also said that they would like to see both funds based on multi-factor and single-factor indices. Taken with the interest in smart beta, the report suggests that the development of ETFs based on advanced forms of equity indices was now by far the highest priority for investors.

Indeed, pointing to the fall in the number citing additional development with regard to emerging markets (which has drifted down from 49% back in 2012 to the figures of 34% last year), the report suggests that investor demand is shifting from emerging markets to new forms of indices.

Still, the demand for exotics shouldn't obscure the fact that 71% of respondents use ETFs for broad market exposure versus 48% who use them to obtain specific sub-segment exposure. The survey points out that the preference for broad market exposure is even more pronounced when looking at answers for specific asset classes where 95% of respondents use broad market ETFs for equity investments, and 82% and 87% of respondents use broad market ETFs to invest in government bonds and corporate bonds, respectively.

Consistent with this, the survey found little appetite for discretionary active strategies delivered in an ETF wrapper with only 14% of respondents mentioning it and actively managed also coming up as the least desired future development. In line with this, 93% and 86% of respondents said they were satisfied with their use of ETFs in equities and government bonds and only 45% and 33% were satisfied with the use of ETFs in infrastructure or hedge funds respectively.

"It thus appears that, while ETFs indeed offer numerous possibilities to move beyond traditional passive investing, the principal use of ETFs for traditional asset classes remains long-term investing in broad market indices," the report says.