Nasdaq acquires top RIA in ‘smart beta’ play

Nasdaq, one of the top builders of the indexes backing ETFs, said Monday it would acquire an investment advisory firm that specializes in souped-up “smart beta” benchmarks.
The Nasdaq OMX Group Inc.’s $225 million cash-and-debt deal for Dorsey Wright & Associates, a provider of investment strategies, model portfolios and web-based portfolio analytics, comes as competition amps up in more exotic corners of the ETF business.
It also accelerates consolidation in the business of selling investment data to financial advisers and other investment firms, coming on the heels of last month’s acquisition of Russell Investments by FTSE owner London Stock Exchange Group PLC.
Dorsey Wright, which licenses indexes used by 17 ETFs and has $6 billion of AUM in its licensed products, is one of the U.S. firms that’s profited from a new wave of demand for exotic ETF strategies used by financial advisers. Its clients include the growing suite of smart beta funds offered by PowerShares, a unit of the fund manager Invesco, and First Trust Advisors.
Interest in deviating from market-cap-weighted indexes to boost returns or manage market risk is not a new phenomenon. The traditionally dominant index providers — among them S&P Dow Jones Indices, Russell Investments and FTSE Group — have for years offered versions of their popular indexes “tilted” in exposure to companies with “value” or “growth” characteristics, for instance, or to those paying plump dividends.
(More: Russell rejiggers index benchmarks)
By contrast, market-cap-weighted funds allocate to funds in proportion to their market size, meaning listed companies with higher valuations earn the lion’s share of an investor’s dollars.
By using a set of rules to deviate from the market, smart beta managers claim to offer the possibility to emulate the outperforming strategies of active managers, but at a lower cost. Expense ratios on funds in the space tend to be lower than those supporting active managers.
Providers of smart beta indexes have in recent years been lifted by investor and adviser interest and a marketing push by fund providers looking to compete with plain-vanilla index funds, which remain dominant.
But smart beta is growing faster. Today, $1 of every $5 moving into ETFs goes into products that Morningstar Inc. calls “strategic” beta, a term used interchangeably with smart beta. (Morningstar also licenses indexes to fund companies.)
“More and more ETFs are coming into the market — it’s what I call ETF alchemy,” said Dorsey Wright co-founder Tom Dorsey. “It’s taking these ETFs together and adding them together to create something different.”
Some prominent investment theorists say the products frequently fail to live up to their billing, delivering little on their promise to significantly enhance returns and underselling to advisers their own risks in clients’ portfolios.
Dorsey Wright provides data to some 30,000 financial advisers, brokers and consultants, as well as portfolios based on its relative strength strategy, which ranks stocks based on their past price movement, with the expectation that stocks with the greatest price movement will likely continue on that trend. That’s often called a “momentum” strategy.
Dorsey Wright’s Technical Leaders index forms the basis of the PowerShares DWA Momentum Portfolio (PDP), an ETF with $1.6 billion under management. They also are used as the basis of the $1.31 billion First Trust Dorsey Wright Focus 5 ETF (FV), which launched last year and quickly gathered assets from the firm’s built-in clientele of advisers who use its data.
Invesco and First Trust Advisors did not respond to a telephone call and an email requesting comment.
Other firms finding new footing in the space include WisdomTree Investments Inc., a popular ETF firm that builds its own indexes such as currency-hedged international indexes, and Research Affiliates, whose “smart” methodology is used by a number of fund companies to reshuffle both stock and bond markets.
“Smart beta is outpacing the overall passive world because I do think investors are looking for … a smarter way to make those passive investing choices,” said Adena T. Friedman, a president at Nasdaq.
The deal is expected to close by the end of March, and would add to Nasdaq’s suite of 156 licensed ETFs.
“Index licensing fees tend to be very sticky,” said Stephen Ellis, a Morningstar analyst. “The rationale for the merger is pretty straightforward.”